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SCANA Corp. Dividend Stock Analysis

Summary SCANA Corp operates in electric and gas utilities in North Carolina, South Carolina and Georgia. SCANA Corp is a dividend contender having raised dividends for 15 consecutive years and has a Chowder Rule of 5.8. SCANA Corp’s new facility construction in S.Carolina is seeing higher costs and delays resulting in a credit rating downgrade from both Moody’s and Fitch. SCANA Corp (NYSE: SCG ) is an electric and gas utility company operating in North Carolina, South Carolina and Georgia. It owns nuclear, coal, hydro, natural gas and oil, and biomass generating facilities. The major subsidiaries include: South Carolina Electric & Gas – provides electricity and natural gas throughout South Carolina. A regulated public utility and principal subsidiary of SCANA Corporation, SCE&G generates, transmits, distributes and sells electricity to over half a million customers in 24 counties and provides natural gas to customers in 36 counties. PSNC Energy – provides natural gas services in North Carolina. A regulated public utility, PSNC Energy purchases, sells and transports natural gas to more than 508,000 residential, commercial and industrial customers. SCANA Energy – markets natural gas services in Georgia. A leading natural gas marketer, SCANA Energy serves about 460,000 residential, commercial and industrial customers statewide. Other subsidiaries include: SCANA Energy Marketing Inc (markets natural gas and provides energy-related services), SCANA Services Inc (provides administration, management, and other services to SCANA subsidiaries), South Carolina Generating Company Inc (supplies electricity for SCE&G), and South Carolina Fuel Company Inc (fuel supplier for SCE&G). (click to enlarge) (Source: SCANA 2015 Wells Fargo Energy Symposium Presentation ) Corporate Profile (from Yahoo Finance) SCANA Corporation, through its subsidiaries, engages in the generation, transmission, distribution, and sale of electricity to retail and wholesale customers in South Carolina. It owns nuclear, coal, hydro, natural gas and oil, and biomass generating facilities. The company also purchases, sells, and transports natural gas; offers energy-related services; and owns and operates a fiber optic telecommunications network, ethernet network, and data center facilities in South Carolina. In addition, it offers tower site construction, management, and rental services, as well as sells towers in South Carolina, North Carolina, and Tennessee. As of December 31, 2014, the company supplied electricity to approximately 688,000 customers; and provided natural gas to approximately 859,000 residential, commercial, and industrial customers in North Carolina and South Carolina, as well as markets natural gas to approximately 459,000 customers in Georgia. It serves municipalities, electric cooperatives, other investor-owned utilities, registered marketers, and federal and state electric agencies, as well as chemical, educational service, paper product, food product, lumber and wood product, health service, textile manufacturing, rubber and miscellaneous plastic product, and fabricated metal product industries. The company was founded in 1924 and is based in Cayce, South Carolina. A Closer Look SCANA Corp operates both in electric and gas utility sectors. This has been identified in the industry as the path to growth going forward. Other competitors who operated solely in the electric-only business, have started purchasing assets in the gas-utility business in order to diversify and achieve growth. We have seen this lately with the moves from Southern Company (NYSE: SO ) acquiring AGL Resources Inc (NYSE: GAS ); and Duke Energy (NYSE: DUK ) acquiring Piedmont Natural Gas (NYSE: PNY ). The moves are motivated by the fact that electric-only utilities are seeing declining revenues over the years due to a combination of energy conservation, energy efficiency and shift towards independent power generation/natural gas usage. In addition, power generating companies are moving to secure natural gas infrastructure as the industry moves to accommodate the US government mandate targeting power plants to cut carbon emissions by 32% (by 2030) on the 2005 levels. Most of the CEOs in the utility industry have accepted the terms and do not intend to fight against the mandate. SCANA has an advantage here as the company is ahead of competition in securing the electric and natural gas infrastructure. In addition, a major part of the company’s power generation comes from zero-emitting sources: hydro and nuclear. The company also has an advantage by operating in North and South Carolina, which is seeing population growth as residents move to these states where cost of living is lower. (click to enlarge) (Source: SCANA 2015 Wells Fargo Energy Symposium Presentation ) SCANA intends to grow earnings in a target range of 3%-6% (95% of which comes from regulated operations) and analysts expect a growth rate of 4.45% over the next five-year period. Credit Rating Downgrades Two rating agencies, Moody’s and Fitch, downgraded SCANA Corp earlier this year. Moody’s gives the company a Baa3 credit rating with a “Negative” outlook ( downgraded in Sep 2015 ). Fitch gives the company a “BBB-” with a “Stable” outlook ( downgraded in May 2015 ). The rating downgrade was mainly due to the delay and cost of the construction of new nuclear reactors in Jenkinsville, South Carolina. The costs are expected to rise to $11B from the initial $9.8B price tag and completion of Unit 2 reactor will be pushed out three years to 2019. SCANA has announced that the delay and related cost increases are due to design and fabrication issues associated with the production of submodules used. Moody’s issued the following statement with the ratings downgrade: “The negative outlooks reflect the projected deterioration in the financial profile across SCANA and its subsidiaries over the next few years” said Ryan Wobbrock, Assistant Vice President. “Although the supportive regulatory environment in South Carolina helps assure the recovery of new nuclear build expenses at SCE&G, we see leverage ratios rising across the family” added Wobbrock. The negative outlooks for SCANA and SCE&G incorporate the 2 September South Carolina Public Service Commission (SCPSC) vote of approval for a revised cost and construction schedule on the Summer new nuclear project. Moody’s views the SCPSC support as a material credit positive because it allows SCE&G to recover increased costs over a protracted time period. Through LTM 2Q15, SCANA and SCE&G produced cash flow to debt metrics of around 14% and 18%, respectively. However, over the next twelve to eighteen months, we expect each company to produce cash flow to debt below 15%, as capex for the nuclear spend reaches its highest levels (i.e., as of the 2Q15 Base Load Review Act (BLRA) filing, new nuclear gross construction capex is projected to be around $776 million for the 2015 period, $1,077 million for 2016, and $1,003 million for 2017), accompanied by an increasing debt load. We see the annual BLRA revenue increases, which recover Construction Work in Progress costs, as insufficient to improve the current negative trend of financial performance through 2019. Dividend Stock Analysis: Financials Expected: A growing revenue, earnings per share and free cash flow year over year looking at a 10-year trend. A manageable amount of debt that can be serviced without affecting future operations. (click to enlarge) (Source: Created by author. Data from Morningstar) (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The utility industry is resilient and has seen steadiness over the years. However, revenue has continued to face some pressure over the years although the earnings have seen steady rise since 2011. The debt load is stable over the course of time although high at $6.3B (vs. equity of $5.4B) resulting in a debt/equity of 1.16. The company’s balance sheets show a current ratio of 0.90. Credit ratings: S&P gives it a “BBB+” credit with a “Stable” outlook. Moody’s gives the company a Baa3 credit rating with a “Negative” outlook (downgraded in Sep 2015). Fitch gives the company a “BBB-” with a “Stable” outlook (downgraded in May 2015). SCANA’s yield to maturity is as shown below: (click to enlarge) (Source: Morningstar) Dividends and Payout Ratios Expected: A growing dividend outpacing inflation rates, with a dividend rate not too high (which might signal an upcoming cut). Low/Manageable payout ratio to indicate that the dividends can be raised comfortably in the future. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: Utility companies are slow and steady growers and are perfectly suited for long-term dividend investors. SCANA is a Dividend Contender having raised dividends consecutively for 15 years. The 1-, 3-, 5-, and 10-year dividend CAGRs are 3.3%, 2.6%, 2.2%, and 3.8% respectively. Coupled with a current dividend yield of 3.61%, SCANA has a Chowder Rule number of 5.8. The current payout ratio is 41%. Outstanding Shares Expected: Either constant or decreasing number of outstanding shares. An increase in share count might signal that the company is diluting its ownership and running into financial trouble. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The number of shares have steadily increased over the years. Book Value and Book Value Growth Expected: Growing book value per share. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The book value has trended upwards at a good pace over the years. Valuation To determine the valuation, I use the Graham Number, average yield, average price-to-sales, and discounted cash flow. For details on the methodology, click here . The Graham Number for SCANA with a book value per share of $37.92 and TTM EPS of $5.27 is $67.05. SCANA’s average yield over the past five years was 4.39% and over the past 10 years was 4.44%. Based on the current annual payout of $2.18, that gives us a fair value of $49.66 and $49.10 over the 5- and 10-year periods, respectively. The average 5-year P/S is 1.42 and average 10-year P/S is 1.21. Revenue estimates for next year stand at $34.41 per share, giving a fair value of $48.86 and $41.63 based on 5- and 10-year averages, respectively. The consensus from analysts is that earnings will rise at 4.45% per year over the next five years. If we take a more conservative number at 4%, running the three-stage DCF analysis with an 8% discount rate (expected rate of return), we get a fair price of $92.86. The following charts from F.A.S.T. Graphs provide a perspective on the valuation of SCANA. (click to enlarge) (Source: F.A.S.T. Graphs ) The chart above shows that SCANA is slightly overvalued. The Estimates section of F.A.S.T. Graphs predicts that at a P/E valuation of 15, the 1-year return would be 3.88%, confirming that the valuation is high. (click to enlarge) (Source: F.A.S.T. Graphs ) Conclusion Electric utilities in general have seen slower sales industry-wide amid a combination of energy conservation, energy efficiency and shift towards independent power generation/natural gas usage. Coupled with the new regulations from the US government to reduce carbon emissions, electric utilities have started focusing a shift away from dirty fuels such as coal. SCANA has operations concentrating on the nuclear field and already owns a lot of the natural gas infrastructure. However, the capex costs from the construction of new nuclear facilities in South Carolina are ballooning and has resulted in ratings downgrade from both Moody’s and Fitch; and chances of an upgrade anytime soon are low. Earnings are expected to grow at 4.45% over the next five years and dividend growth will lag a bit, although the company has some leeway to grow those dividends making the investment lucrative. The company appears slightly overvalued based on the valuation metrics used above. If we give equal weight to all metrics used above, we get a fair value of $57.95. An added risk for investors is the rise of interest rates by the US Fed. Bond substitutes such as utility stocks suffer in a rising rate environment and investors should stay weary. Full Disclosure: None. My full list of holdings is available here .

Hard Proof CEF Investors Are Irrational

Summary Closed-end funds offer significant opportunities for swing traders thanks to the irrational inflows/outflows of some investors. Recent movements in high yield CEFs, when compared to JNK and HYG, demonstrate how irrational the CEF world can be. While high risk, trading CEFs more aggressively can offer significant rewards if done properly–and significant losses if done poorly. Traditional money managers tend to dissuade clients from investing in closed-end funds, citing fees, the dangers of leverage, and the shrinking CEF universe as causes for concern. At the same time, income-hungry investors are rightly dissatisfied with the low-yielding income options in both the ETF and mutual fund universe, while the lack of leverage and stricter mandates of many of those funds limits their managers’ abilities to deliver high performance to clients. On top of that, CEFs have the unique value of trading sometimes at a steep discounts or premiums to NAV and diverging from historical average prices, providing opportunities to rotate in and out of CEFs to boost returns on top of providing a strong income stream. This is hard to do, and requires both diligence and knowledge. But it is also an excellent feature of the CEF universe that investors can use to their advantage. One other advantage of the CEF universe: many of the investors in these funds are slow to act and irrational. For the most part, this results in volatility and severe underperformance, as we have seen this year: (click to enlarge) But it also provides excellent mispricing opportunities that more savvy and diligent investors can take advantage of. This is especially the case with one fund: The Pimco High Income Fund (NYSE: PHK ), although its peers are showing signs of increasing divergence from their underlying investments, providing additional opportunities to swing trade these funds. Proof of Irrational PHK Investors There are many moments in the CEF universe that prove the irrationality of many market participants. The quasi-historical FOMC meeting and rate hike of last week is a phenomenal example of that irrationality-and the opportunity it provides. If we rewind three months, we see that there was relative stability in the world of high yield closed-end funds until quite recently: (click to enlarge) The Dreyfus High Yield Strategies Fund (NYSE: DHF ) and the Pioneer High Income Trust (NYSE: PHT ) remained relatively flat until earlier this month, when panic caused those funds and PHK to suffer steep declines. The fact that PHK continued to appreciate to a peak premium of 30% above NAV throughout October and November demonstrates the irrationality of many of the investors in this fund. This does not mean that I dislike it; on the contrary, it is one of the best managed and best performing (on a NAV basis) high income CEFs with one of the longest track records. But the way this strong performance attracts too much capital makes it a sometimes crowded trade worth betting against at peaks and buying at troughs. Proof of Irrational High Yield CEF Investors Recent history demonstrates that the other two funds do not have significantly more rational investors (probably because there is some overlap between them and PHK). Let’s look at three days of trading, starting with December 15th. This is shortly after the high yield panic caused by major headlines about redemptions and liquidity issues hit the entire high yield sector. (click to enlarge) Alongside the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ), our three high yield CEFs experienced strong price growth, with PHK outperforming significantly. The next day, the “high yield is oversold” narrative continued across the financial press, with commentators insisting this was a wonderful “buy-the-dip” opportunity, and the rising tide raised all boats again: (click to enlarge) Again DHF and PHK outperform significantly, bringing investors who bought the dip nearly double-digit capital gains in a couple short days. After the FOMC meeting and the historic decision to raise the Fed funds rate target by 25 basis points, the market’s sigh of relief was short-lived and equities sold off after a brief rally shortly after the announcement on Wednesday afternoon: (click to enlarge) Yet the high yield CEFs weren’t sold off at all. In fact, DHF and PHT saw a slight uptick and PHK was flat, indicating that some concern was trickling into these CEFs, but not enough to cause the sell-off seen in JNK and HYG. The short-term implications of this are clear: if JNK and HYG sell off again for another day or two, CEFs investors will likely panic and cause outsized declines. The selling opportunity will be obvious. But if the high yield market broadly fails to sell off, the irrational inflows into these high yield CEFs could turn into exuberance. Is it Time to Short PHK? With PHK up and JNK/HYG down, it seems a no-brainer to short PHK in anticipation of the inevitable cratering that PHK usually endures after a run-up. There are two reasons why this would be unwise right now. Firstly, the run-up in PHK happened over the course of a couple of days, which is rare for the name; historically, it runs up steadily over several weeks or months as inflows cause the premium to grow and grow. With that not being the case here, the price run-up is not founded on strong volumes and could not be victim to the typical outflow pattern of the past. Secondly, the technical indicate PHK could stay horizontal or even go up in the short term. Looking at the relative strength index (RSI) for the name, we see a sharp uptick in the last few days, but it remains at the lower end of the range it has seen since its dividend cut: (click to enlarge) And it is more in its mid-range historically: (click to enlarge) With a relatively modest RSI relative to the weakness in the high yield market, there is a possibility of a short-term decline but it is less obvious than in early November, when I sold out of the name, and in December, when I wish I’d shorted it. A Timeline to Act If now is not necessarily the time to short PHK, keeping track of the fund’s premium to NAV and the rate of change for HYG and JNK may provide a viable buy/sell signal to indicate when to act. Because it can take several days after a sharp move for a CEF to reset according to the market that it acts within, the divergence between high yield CEFs and the high yield bond market provides an opportunity for swing trading on a time frame of at least one week, and most likely several weeks. A quick look at when this month’s carnage began will demonstrate the timeframe with which to act and the signal to act on. (click to enlarge) The weakness in high yield began in earnest on December 7th, but was hinted at in the prior week on December 3rd. At the same time, the three high yield CEFs under consideration were up on average, indicating the beginning of a divergence: (click to enlarge) The sell signal was weak on the 3rd when the CEFs were on average up 1.44% and the high yield ETFs were down only slightly, but the sell signal got stronger on a second day of declines for ETFs and a second day for CEFs. The weakness in the junk ETFs only percolated into the CEFs on December 8th, and only really reached a level of significant declines the two days after, meaning a swing trader had four trading days (from the 3rd to the 8th) to sell off the high yield CEFs on the warning signal that they were becoming relatively overvalued to the ETFs that invest in the same underlying asset class. If we look at the last five days of trading, and note Monday’s weakness in high yield markets versus the strength in high yield CEFs at the same time, we can conclude that a similar week-long swing-trade opportunity is coming again: (click to enlarge) Conclusion A look at recent history shows how irrational the CEF universe is and how prone it is to volatility. This does not mean these funds should be avoided, but that they need an approach most income-seeking investors will not appreciate: more aggressive swing trading on weaknesses and strengths to fully take advantage of the opportunities the funds provide. If this sounds dangerous, that’s because it is; swing trading and rebalancing between CEFs will not only incur transaction costs and short-term capital gains taxes, but if done poorly will either lock investors into funds at too high of a price or will incur losses from poorly timed and executed trades. For instance, people who bought PHK in July and August when the fund showed comparative weakness faced massive losses after the surprise dividend cut in September. This is why the swing-trade approach to CEFs should only be done when investors have confidence and conviction in their understanding of the funds. If they can gain this perspective, the potential for very high returns by being a CEF contrarian is outstanding.

Lazard Explains Benefits Of Multi-Factor Smart Beta

Smart-beta strategies attempt to provide better risk-adjusted returns by using measures other than market capitalization to weight portfolio holdings. Historically, these alternative weightings have produced higher Sharpe ratios, a measure of return per unit of risk, and this is why they’ve earned the “smart” moniker in the view of their advocates. Smart-beta strategies can be considered as occupying the middle-ground between active and passive investing, with rules-based methodologies (like passive investing) that nevertheless deviate from broad market benchmarks (like active investing). Distinct smart-beta strategies and funds can either be “single factor” or “multi-factor,” as explained in Lazard’s December 2015 Letter from the Manager: A Better Kind of Beta , which reviews five such “factors” before going on to make the case for multi-factor investing in general, and Lazard’s own multi-factor strategies in particular. Style Factors A “factor” is any consistent characteristic that academic research has shown explains the risk or return characteristics of stocks. Common style factors include: Value – Value-investing is championed by the most successful investor of all time: Warren Buffett. But “value” can be defined in a number of ways, and not all measures are as likely to produce superior results. In Lazard’s view, a combination of “cyclical” (such as price-to-book) and “defensive” (such as cash flow) measures provides the most consistent exposure. Momentum – Stocks going up tend to continue going up – and vice-versa. At the same time, what goes up must come down – the question is “when?” Lazard recommends using measures other than simply price momentum to judge market sentiment – including macroeconomic data releases. Low Volatility – Low volatility stocks have added appeal in the wake of the financial crisis, but Lazard thinks this factor can best be exploited not by allocating specifically to low-volatility stocks, but by targeting low volatility in portfolio construction. Lazard’s process identifies low-volatility companies with attractive fundamentals. Quality – Lazard’s take on “quality” compares a company’s (paper) earnings and (actual) cash flow. Accounting rules and the market’s short-term focus may put undue emphasis on the former, whereas an analysis of a company’s cash flow may provide a more accurate estimate of its earnings strength. Growth – While “momentum” is a growth measure determined by share price, the “growth” factor considers a company’s financial statements. Lazard’s approach is designed to identify stocks that are well-positioned to experience above average growth in the future. Multi-Factor Advantages Multi-factor investing offers the advantages of diversification and flexibility. Although individual factor indexes have outperformed since 1988, returns are cyclical and different factors outperform at different times. Diversified multi-factor investing thus works to mitigate volatility, which can limit account drawdowns. Multi-factor investing also promises the benefit of flexibility, wherein outperforming factors can be emphasized. Single-factor and passive cap-weighted investing has no such flexibility. Lazard boasts of its own “multi-factor pedigree,” with “a set of balanced style criteria” that have been researched and refined over the past two decades. The firm has been implementing multi-factor approaches in live portfolios over the entire in period, in a variety of global-, regional-, and country-specific scenarios. In fact, Lazard was doing smart beta before smart beta was even known as smart beta – Lazard used to call it “quantitative” or “systematic” investing. “Not all smart-beta strategies are created equal,” according to Lazard, and in the firm’s opinion, exposure to several factors provides far greater consistency of performance over both the long- and short-term. Lazard’s own multi-factor strategies have “the benefit of the skill and long-standing experience” of the firm’s multi-factor selection, combination and diversification, as well as ongoing research and risk monitoring. For more information, download a pdf copy of the letter .