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Dividend Aristocrats Part 24 Of 52: Consolidated Edison

Summary See why Consolidated Edison is the ultimate ‘tortoise stock’. The company has paid increasing dividends for 41 consecutive years. Are you the type of investor that will benefit from Consolidated Edison stock? Aesop was born into slavery in Greece around 620 BC . His tremendous intelligence did more than earn him his freedom. He rose to become a respected advisor to kings and city-states. One of Aesop’s most famous fables is the tortoise and the hare. An arrogant, speedy hare brags to a plodding turtle about how fast he is. The plodding turtle challenges Aesop to a race. The hare took a commanding lead and looks back, feeling confident that he will win the race. The hare decides to take a ‘power nap’. The slow and steady turtle passes the hare and wins the race. The moral of Aesop’s fable: slow and steady wins the race . Aesop’s story of the tortoise and the hare reminds me of Consolidated Edison (NYSE: ED ). (click to enlarge) Consolidated Edison’s History Consolidated Edison can trace its history back to 1823 – nearly 200 years ago. Back then, the company was known as New York Gas Light Company. In 1884, representatives of several gas light utilities throughout New York came together and consolidated their respective companies into a new business – the Consolidated Gas Company of New York. The company continued to grow and acquire gas, electric, and steam companies serving New York City and Westchester County. In 1936, the company changed its name to Consolidated Edison. Consolidated Edison has paid increasing dividends for 41 consecutive years . The company is the only utility in the S&P 500 with 30+ years of increasing dividends. Consolidated Edison’s dividend growth over the last 41 years is shown below: (click to enlarge) Source: Data from Yahoo! Finance Consolidated Edison Business Overview Consolidated Edison is primarily a regulated utilities business. The company has generated 89% of its revenue from its regulated utilities business segments through the first 9 months of fiscal 2015 . (click to enlarge) Source: 2015 EEI Conference Presentation , slide 25 The company operates in 3 segments: CECONY O&R Competitive Energy Business CECONY stands for C onsolidated E dison C ompany O f N ew Y ork. O&R stands for O range & R ockland. Together, these two segments make up Consolidated Edison’s regulated utilities business. The company’s Competitive Energy Business segment which participates in infrastructure projects, provides energy related products to wholesale and retail customers, and sells electricity purchased on wholesale markets to retail customers. Low Stock Price Standard Deviation & High Yield Investing in ‘turtles’ is not right for everyone. If you are looking for a high dividend yield, safety, and inflation matching (or beating) growth, then Consolidated Edison is a suitable investment. The company’s stock is currently offering investors a high dividend yield of 4.2%. For comparison, the 20 year U.S. Treasury Bond ETF (NYSEARCA: TLT ) is offering investors a yield of just 2.6%. Unlike a bond, Consolidated Edison’s dividend payments are growing (albeit slowly). The company has managed dividend growth of 1.4% a year over the last decade. This is about in line with inflation over the same period. The company should grow its dividend payments faster over the next decade (more on that in the future growth section of this article). Consolidated Edison has a 10 year stock price standard deviation of just 16.7%; the second lowest of any large cap dividend stock with 25+ years of dividend payments [for reference, Johnson & Johnson (NYSE: JNJ ) has the lowest]. You may be wondering… Why does stock price standard deviation matter? There are two answers. First, lower stock price standard deviation means a less ‘bouncy’ ride on your way to total returns. Lower dips make Consolidated Edison stock easier to hold as compared to more volatile stocks. Second, stocks with low stock price standard deviations have historically outperformed the market . That’s why low stock price standard deviation is one of the ranking metrics used in The 8 Rules of Dividend Investing . The image below shows the relative outperformance of the S&P Low Volatility Index over the last decade. The S&P 500 Low Volatility Index is comprised of the 100 lowest volatility stocks in the S&P 500 index. (click to enlarge) Source: S&P 500 Low Volatility Index Factsheet Consolidated Edison’s Future Growth Potential & Total Returns Consolidated Edison grew its earnings-per-share at 3.4% a year over the last decade. Earnings grew around 5%, but the company partially financed itself through share issuances, which dilutes earnings-per-share. In total, the company’s share count has grown at around 1.4% a year over the last decade. Going forward, I Consolidated Edison is expected to grow its earnings-per-share at around 3.5% a year. This number is very close to its 3.4% 10 year historical compound earnings-per-share growth rate. Consolidated Edison’s management is targeting a 60% to 70% dividend payout ratio. The company currently has a 68.8% dividend payout ratio; on the high end of management’s range. As a result, I believe that the company’s dividend payments will increase at either the same rate as earnings-per-share growth for the company, or slightly slower. Investors in Consolidated Edison should expect total returns of around 7.5% a year from the company’s stock. Returns will come from earnings-per-share growth of around 3.5% a year and dividends of ~4% a year. Consolidated Edison stock has a payback period of 16 years using an assumed growth rate of 3.5% and the company’s current share price and dividend. More Safety: Invest In What You Understand Consolidated Edison is an easy to understand stock . The company makes the vast majority of its profits selling electric and gas utility services to both business and residential customers on the East Coast. Other investors have taken notice of Consolidated Edison’s durable geography based competitive advantage. Here’s what Lanny at Dividend Diplomats had to say about the Consolidated Edison : “I understand utilities, I know how they physically work and I know what benefit and value it provides: Providing energy to fuel the day-to-day of operations. Let’s think big businesses, industries, etc., all the way to our entertainment platforms and this stems into our very own households. The need is and for now – will always be there, therefore, this is a very used product that will always be used.” It is very, very likely that Consolidated Edison will be around for a long time in the future. The company operates in a highly regulated industry that creates natural local monopolies. Moreover, the company operates a business that we all use every day (though not necessarily from Consolidated Edison, depending on where you live) – electricity and gas utility services. Peter Lynch is one of the most successful institutional investors of all time. Here’s what he has to say about investing in what you know: (click to enlarge) Final Thoughts: Who Should Buy Consolidated Edison Consolidated Edison stock is not for everyone . The company has a passable-but-not-great expected total return of 7.5%. As a utility, Consolidated Edison does not have rapid, or even average, growth potential. The company’s high dividend yield and high levels of safety (both qualitatively and quantitatively) make it an ideal choice for risk-averse investors looking for high yielding investments that will pay inflation adjusted (or better) dividend payments. Consolidated Edison is the prototypical tortoise investment . Slow and steady dividend growth wins the race.

Northwestern Corporation: Great Business Fundamentals

Summary Montana has a healthy, stable population that pays its utility bills. Hydroelectric generation acquisition changed the company for the better. The acquisition did increase leverage. Debt is manageable, but free cash flow should go to paying down debt. NorthWestern Corporation (NYSE: NWE ) is an electricity and natural gas provider that serves the energy needs of hundreds of thousands of customers in Montana, South Dakota, and Nebraska. Unlike many utilities that have diversified into non-regulated activities, NorthWestern remains a pure-play regulated utility. Management has been wise, making strong moves to diversify away from coal-fired generation in a bid to lower regulatory risk. In turn, investors have rewarded this move, with shares returning roughly double the return of the broader utility index since the September 2013 announcement of the purchase. Will this long-term outperformance continue? Renewable Energy Diversification Those that have followed my work know that I have been especially critical of utilities that have not begun to meaningfully diversify away from coal, shifting power generation into cleaner plays such as natural gas and hydroelectric generation. Coal will continue to play an important, but shrinking, role for most utilities in providing stable energy generation for some time. We all know that sometimes the wind doesn’t blow or the water doesn’t run. But its days of dominance are numbered and utilities must position themselves for a future where coal is not the primary source of power generation, primarily due to continued pressure from environmental regulation. From what I’ve found, utilities in the Midwest have been especially guilty of ignoring renewables. NorthWestern Corporation, operating right next door to many of these slow-to-adapt utilities, has not been ignoring industry trends. The $900M acquisition of eleven hydroelectric facilities from PPL Montana was a game-changer for the company, shifting more than 50% of available base-load generation to renewable water and wind. Hydroelectric is a great source of power for utilities to meet light-load requirements on most operational days. There is no fuel cost to worry about, which reduces operational headaches, and the assets are obviously quite clean when it comes to greenhouse gas production and waste. Best of all, NorthWestern got these facilities for a steal of a price. Montana In Focus The vast majority of NorthWestern’s earnings comes from its Montana operations. When you think of Montana, you probably think of something like this: ‘ * Wildnatureimages.com This honestly isn’t too far from the case. Montana is a vast state, with low population density and a high concentration of people over the age of 65. However, this doesn’t make it a poor market for a utility. The unemployment rate has remained under the U.S. national average for many years (currently at an incredibly low 4.0%), and population growth remains stable. * NorthWestern Energy Investor Presentation Along with this, bad debt write-offs for NorthWestern are incredibly low, even during the recession where you would expect a jump in defaults. With more than 80% of Montana revenue coming from residential customers, low unemployment and bad debt write-offs creates a situation of high stability and predictability when it comes to company earnings. For utility owners, this should be far more important than chasing growth potential. Steady as she goes is the name of the game. Operating Results (click to enlarge) Electric operations revenue growth has accelerated, especially for full-year 2015, due to approval of increased rates related to the hydroelectric acquisitions that have come into effect. Gas operations revenue has fallen, but like with all natural gas utilities, this is a function of the underlying commodity price rather than a lack of demand. As natural gas prices have fallen, the cost of gas passed along to consumers as part of rider agreements falls as well, resulting in lower revenue. Investors should remember, however, that NorthWestern’s fixed margin per unit of gas sold remains the same. Lower gas prices mean higher gross and operating margins for the natural gas division, which we can see coming down in 2015’s estimated full-year results. (click to enlarge) As I usually do with utilities, I look to see that operational cash flow can cover capital expenditure requirements and dividend payments. If not, the utility is likely stuck in a cycle of taking on debt to cover its obligations. For NorthWestern, total cash flow from operations will grow greatly in 2015, eliminating some of the slightly larger deficits we saw in 2013 and 2014, likely a result of larger capex requirements for its new hydroelectric facilities. Overall, leverage for NorthWestern has gone up as a result of its hydroelectric and wind acquisitions, which cost a touch over $1B. Total long-term debt now stands at $1.8B, putting its net debt/EBITDA ratio at around 4.5x, which is on the high side but manageable for the time being. Management here has been traditionally cautious – all of NorthWestern’s debt is non-callable, long-term fixed rate debt. The company does have $455M of debt coming due by 2019 ($150M 2016, $55M 2018, $250M 2019), which it will have to refinance. I’d expect this to price around 4.5% on mid-term extensions (coming due in 2030) which will actually reduce the company’s interest expense somewhat given the 6%+ coupons these issuances have carried. Conclusion Overall, NorthWestern is a well-run utility. Management seems to be taking all the right steps and the 3.75% annual dividend yield is solid. 12.5x ttm EV/EBITDA is on the high side, but the company likely carries a premium given the strong growth performance and future earnings profile. I wouldn’t be a buyer at current prices, but I’m keeping the shares on my watchlist.