Tag Archives: etf

Should You Stick With Duke Energy After A Rough Year?

Duke Energy has received the first two regulatory approvals to proceed with its acquisition of Piedmont. The annual average residential electricity sales will drop 0.5% in 2016, but the prices increase will offset the impact of unfavorable weather conditions. Duke Energy is trading at very reasonable valuation and offers a very attractive dividend yield of 4.58% at current levels. Duke Energy (NYSE: DUK ) has received the first two regulatory approvals to proceed with its acquisition of Piedmont Natural Gas (NYSE: PNY ). Now the approval of Piedmont’s shareholders and permission from the N.C. Utilities Commission is required to complete the transaction. So far the process has progressed smoothly, and Piedmont’s shareholders will meet on January 22, for that purpose. Duke Energy will become the largest gas utility in the state and N.C. Utilities Commission could raise concern over the dominance position, but the management expects to complete the transaction on time. Duke Energy, like most of the other utility stocks, underperformed during 2015 primarily due to uncertainty over interest rate hike. Now finally, Fed has raised the rate and would continue to hike steadily during 2016. The only downside of interest rate increase for Duke Energy is that incremental financial burden could restrict the earnings growth. In this scenario, the investor might be concern over the sustainability of future dividend payments. However, consistently growing regulated electric & gas operations and stout cash flow position will enable Duke Energy to bear the shock and continue to return cash to shareholders. So far this year, Duke Energy has delivered satisfactory performance despite very rough weather conditions. In the coming quarters, the outlook of unregulated utilities is likely to remain challenging primarily due to declining power and natural gas prices and soft electricity demand. On the contrary, regulated utilities will benefit from the supportive regulatory environment, resulting in steady operating earnings growth in 2016. While overall sector earnings are likely to grow 3.7% during, Moody’s (NYSE: MCO ) expects that regulated utilities will witness better operating earnings growth. Source: Factset Duke Energy’s regulated utilities segment recorded operating revenue of $17.09 billion, an increase of only $16 million year-over-year. The flat top-line was due to unfavorable weather during the first half of 2015, but the segment revenue increased 2.7% during the third quarter on the back of mid-single digit increase in electricity demand. Currently, the regulated electricity business is 91.3% of total revenue flowed by 6.4% nonregulated and 2.3% regulated natural gas. Going forward, the addition of approximately $1.4 billion annual sales from Piedmont will significantly increase the revenue contribution of Duke Energy’s existing regulate natural gas business. In the advantageous scenario, the aggressive acquisition of regulated assets will fuel the company’s earnings. (click to enlarge) Source: Company Presentation The commercial and industrial demand is steadily rising, but the mild weather is negatively impacting the demand for residential electricity. The Energy Information Administration (EIA) estimates that annual average retail residential sales will drop 0.5% in 2016, but electricity sales to the commercial and industrial sector will increase by 0.7% and 1.4%, respectively. Source: EIA Duke Energy may continue to witness flat residential usage per customers owing to stable demand and improving efficiency level, but an increase of 0.7% in residential electricity prices will support the growth during 2016. Moreover, the diversified customer base and the addition of new residential customer at a low single-digit, the company added 1.3% new customer over the past twelve months, will boost the top-line at a steady pace. On the other hand, the potential ease in currency headwind and divestiture of poor performing assets could also improve the revenue from international operations. Thus, the trickling down of revenue growth, solid gross margins, and a massive $10 billion investment in gas & electric infrastructure will enable Duke Energy to accelerate an average long-term earnings growth of 4% – 6%. Duke Energy pland to invest approximately $20 billion in new generations and infrastructure development between 2015 and 2019. So far, the company has spent $4.64 billion in CAPEX during 2015, while it generated $5.4 billion in operating cash flow with cash & cash equivalent of $1.37 billion cash. The cash flow position looks pretty healthy, which depict that the company would be able to manage CAPEX and dividend payments without any cut if the interest rate increases further. Duke Energy increases dividends each year, and it has paid the quarterly dividend for 89 consecutive years. Duke Energy is one of the high yield utility stocks and currently, it offers a yield of 4.58%, significantly higher than the average 3.90% yield of large-cap electric utilities in the U.S. Duke Energy has increased the dividend at a CAGR of approximately 2% between 2009 and 2014. Now, the company has recently boosted the increase rate to 4%. The management expressed the intention to increase the future dividend more in line with the long-run earnings growth, which is 4% – 6%. Though interest rate is a threat, the healthy balance sheet will enable the company to maintain the dividend growth. Source: Finviz The balance sheet of the company is very sound with total assets of $121 billion. In contrast, the company has a total debt of $40.2 billion. The debt would increase in 2016 owing to partial debt financing to complete the acquisition and additional debt from Piedmont. Despite the substantial debt, the company’s financial health is likely to remain rigorous as it invests in quality assets to generate growing cash flows, and its total debt to asset ratio, excluding goodwill, is only 0.38 times. Currently, the total debt to equity ratio of Duke Energy is 1.07 times, which seems quite high but is significantly lower than the large-cap electric utilities average and median of 1.38 times and 1.21 times, respectively. Moreover, the interest coverage ratio of 3.85 times depicts that Duke Energy is in a very comfortable position to cover the future interest expense while raising the dividend in line with the earnings growth. Duke Energy delights the investors by raising dividends, which are backed by consistently growing earnings. Unfortunately, Duke Energy is one of the stocks to lose double-digit value during 2015 primarily due to interest rate turmoil throughout the year. On the flip side, Duke Energy is now trading at very reasonable valuation, and its yield has increased due to a steep decline in share price. Duke Energy is currently trading at forward PE of 15.31x, which is slightly less than the utility sector forward PE of 15.5x. That said, Duke Energy is a very decent utility stock to hold for growing dividends and investors should not worry about the interest rate as it is already priced-in.

Enhancing Performance With Low Volatility ETPs

One theme that I will spend more time on in 2016 and beyond is the low volatility anomaly, which has been discussed in considerable detail in the academic world, leading to papers such as the following: In a nutshell, the research supports the claim that low volatility and low beta stocks in the United States and across the globe outperform high volatility and high beta stocks, with low volatility stocks generating substantially higher risk-adjusted returns. Not coincidentally, the groundswell of research pointing to outperformance by low volatility stocks has created a land rush for low volatility ETPs in the first generation of “smart beta” or factor-based investment products in ETP wrappers. Since I believe smart beta or factor-based ETPs is one of the key revolutionary ideas to appear in the investment world in recent memory, I will have a great deal to say about this subject and the many tangential ideas that arise from it going forward. After nine years focusing primarily on the VIX, volatility and related subjects, it is time to charge off in some new directions, starting with some that have a whiff of volatility and ETP innovation. For now, I am going to be content with updating a February 2013 post, with the title The Options and Volatility ETPs Landscape . At that time, I wanted to capture those ETPs that employed a buy-write/covered call approach, employed a put-write strategy, focused on the convertible bond space or targeted low volatility stocks. Well, a lot has changed in the past three years, notably in the low volatility space. This time around, I have some enhancements to the options and volatility ETPs graphic. As is the case with The Current VIX ETP Landscape , I have added yellow stars for those ETPs with an average daily volume of 1,000,000 or higher and pink stars for ETPs with an average daily volume between 100,000 and 1,000,000. Additionally, I have highlighted the new currency-hedged crop of low volatility ETPs by using a red font and have captured the demise of HFIN, a financials buy-write ETF that closed in March 2015 with an X-HFIN designation. (click to enlarge) (source(s): VIX and More) There are a number of other sub-categorizations I will delve into at a future date, but note that whereas FTHI is a buy-write only, FTLB adds an out-of-the-money put. Three other relatively new arrivals, CFO , CDC and CSF , are structured so that they will hold up to 75% of portfolio assets in cash in adverse market conditions. Another intriguing new entrant, SLOW , attempts to avoid sector bias by forcing greater sector diversification than most other low volatility ETPs. So if you found 2015 volatility to be daunting and are looking to dampen volatility in your portfolio in 2016 or tap into the performance benefits of the low volatility anomaly, keep the list above in mind. While comprehensive and including many ETPs with marginal liquidity, this list may not touch upon some of the many new and illiquid products that might be flying under the radar.

Peer Inside The iShares S&P 500 Value ETF

Summary The individual holdings look fairly solid with a heavy exposure to XOM. The sector allocations are going heavy on the financial sector. While those financial firms may benefit from raising short term rates, I’d rather hedge rate risk and add more exposure to utilities. The iShares S&P 500 Value ETF (NYSEARCA: IVE ) is one way to get the value exposure for your portfolio. On the other hand, if you prefer to look at individual sectors you may find the holdings a little more concerning as 25% of the equity is invested in the financial sector. Generally I have tendency to prefer the value side of the index, but going so overweight on financials is an interesting aspect of the fund. Quick Facts The expense ratio is .18%. I have a strong preference for very low expense ratios, so this is a bit higher than I like to see. With over $8 billion in assets under management, it seems better economies of scale could be achieved, but the higher expense ratio may simply reflect more profits to the sponsor of the fund. Holdings I put together the following chart to demonstrate the weight of the top 10 holdings: (click to enlarge) I love seeing Exxon Mobil (NYSE: XOM ) as a top holding. Investors may be concerned about cheap gas being here to stay, but I think money in politics will be around decades (centuries?) longer than cheap gas. Bet against big oil at your own peril. I find the exposure to AT&T (NYSE: T ) interesting simply because the 2.4% weighting is almost twice that of Verizon (NYSE: VZ ). I find the telecommunications sector a little risky because of the intense price based competition brought by Sprint (NYSE: S ). The sector will probably find a solution to the intense competition, but I’ve gotten burned pretty badly by the mining sector where industry competition reached absurd levels and companies opted to focus on lowering their own costs by increasing production and driving down prices. Declining prices for the product combined with increased production and intense capital expenditures is a pretty ugly situation. Outside the Top 10 Outside of the top 10 you’ll find Johnson & Johnson (NYSE: JNJ ) as 1.64% of the portfolio. This is another great dividend company to hold. They have an effective R&D team and a global market presence. Just look at their dividend history and try to come up with a reason that this company shouldn’t be in a dividend growth portfolio: (click to enlarge) Beyond JNJ you’ll also see other dividend champions like Wal-Mart (NYSE: WMT ) and Pepsi (NYSE: PEP ). The heavy exposure to dividend champions is one reason for investors to appreciate the value side of the index. Wal-Mart has been on a massive slide lately but I don’t see it getting much worse before it gets better. The market for equity can be a little too short sighted in valuations. While Wal-Mart is seeing their already thin operating margins get pressed even thinner amid higher wages, they are also the low cost leader. When Wal-Mart raises prices, the rest of the industry should follow. Who will undercut Wal-Mart? Will it be Target (NYSE: TGT )? I doubt Target really wants to do that since they raised wages also and have the same challenge. Sectors Going heavy on financials hasn’t been my style, but increasing interest rates may benefit them more than the rest of the economy. It’ll be interesting to see how much higher the Federal Reserve can push interest rates without crashing the economy. What to Add The biggest weakness here in my opinion is the relatively small position in utilities. Since utilities often have a material correlation with bonds, I’d like to see a little more utility exposure in the portfolio. An investor could modify the exposure by simply adding the Vanguard Utilities ETF (NYSEARCA: VPU ) to their portfolio when using IVE as a substantial holding. Conclusion The expense ratio is a bit high and the concentration in the financial sector is a little higher than I’d like to see. However, the rest of the portfolio exhibits some great traits with a focus on established dividend growth champions that have the size and experience to whether difficult market environments. All things considered, I think there is more to like than to dislike in this portfolio. Some investors with a very long holding period may want to look for options with slightly lower expense ratios. If investors have a shorter time frame or intend to move their positions more frequently the healthy liquidity on IVE should be attractive for creating a smaller bid-ask spread.