Star Wars is awesome… but is that investable? How do you win stock picking contests? How can you exploit deadweight loss from Christmas? In the current episode, we discuss the following question: If Star Wars is going to sell a ton of tickets and if Disney (NYSE: DIS ) owns Star Wars, then does it follow that I should buy Disney? We also chat about stock picking contests and the deadweight loss of Christmas presents.
Unregulated utility companies’ performance likely to stay challenging in 2016 because of weak and volatile power prices. DUK and SO making correct strategic attempts to strengthen regulated operations. Stock valuations for DUK and SO are cheap, as both are trading at discounts to peers and the industry average. 2015 has been a tough year for the U.S. utility sector, mainly because of concerns regarding the Fed interest rate increase; the utility sector ETF (NYSEARCA: XLU ) is down 10% year-to-date. Moving into 2016, given the decline in the power and natural gas prices, U.S. unregulated utility companies’ performance will stay volatile and weak; however, I think U.S. utility companies with significant and growing regulated business operations will stay an attractive investment option for income-hunting investors. Duke Energy (NYSE: DUK ) and Southern Company (NYSE: SO ) are the two U.S. utility companies that have large regulated business operations and are further working to strengthen their regulated business operations, which will provide stability to their revenues and cash flows, and support dividend growths. Moreover, valuations for both the stocks stay compelling. Two Utility Stocks: DUK and SO In recent years, low power and natural gas prices has adversely affected performance of unregulated business operations. As the power and natural gas prices continues to stay weak, I think, 2016 will be another challenging year for the unregulated utility companies. In the volatile unregulated business environment, the U.S. utility companies are working to lower their unregulated business operations, which will positively affect their performance. DUK is among the leading utility companies of the U.S., and has been working to strengthen its regulated business operations by making regulated capital investments; the company is expected to make capital investments of $20 billion in the next four years, which will result in increase in its rate base and support earnings growth. The company is not only upgrading its existing regulated infrastructure, but also diversifying the power generation assets by focusing on renewable energy sources, which will improve its business risk profile and allow it to comply with changing environmental regulations. DUK plans to spend to $3 billion on renewable energy in the next four years. Moreover, in 2016, if the company decides to sell its international unregulated business operations, it will positively affect its stock price and will make its cash flows more stable. Also, once the company successfully closes acquisition of Piedmont Natural Gas (NYSE: PNY ), which is consistent with its efforts to grow regulated earnings, it could opt to undertake more regulated gas business acquisitions to strengthen its gas business. Given the company’s aggressive efforts to strengthen its regulated operations, its cash flows will improve, which will allow it to increase its dividend growth consistently in the coming years. The stock has yield of 4.75% , which is supported by its 14% operating cash flow yield, and makes it an impressive investment option for income investors. Also, investors should keep track of yearly earnings call in February, in which the company will provide update on its 5-year growth expectation, synergies related to PNY acquisition and rate case outlook. Southern Company is another utility stock which stays an attractive investment option for income investors, as it offers a solid yield of 4.7% , which are backed by its operating cash flow yield of 15% . The company generates almost 90% of its earnings from regulated operations, which provides stability to its cash flows. Similar to DUK, SO also is working aggressively to modernize and strengthen its power generation assets. Moreover, once the company’s two construction projects, Kemper and Vogtle Power plants, are completed it will portend well for its long-term earnings. Also, the company has been actively increasing its renewable energy asset base. The company spent more than $2 billion on renewable in 2015, and plans to spend another $1.3 billion in 2016, which is expected to increase its renewable energy portfolio capacity to 2,600 MW. Consistent with its renewable generation assets base growth, the company acquired almost 600 MW of solar assets from First Solar (NASDAQ: FSLR ). And also, completion of SO’s and AGL Resources (NYSE: GAS ) in the later half of 2016 will augur well for the stock price. The company’s efforts to improve its regulated power asset base will support its long-term earnings growth, and its business risk profile will improve, as it will complete pending acquisitions and ongoing construction projects. Also, the company’s cash flows will stay strong to support its dividend growth, which will improve investors’ confidence. Valuation and Summation Unregulated utility companies’ performance is likely to stay challenging in 2016 because of weak and volatile power prices. However, companies like DUK and SO, which are making correct strategic attempts to strengthen their regulated operations, will deliver healthy performances in future years. Both DUK and SO offer solid yields of 4.7% and 4.75%, respectively, which makes them attractive investment prospects for income-hunting investors. Moreover, stock valuations for DUK and SO are cheap, as both are trading at discounts to their peers and the industry average. DUK and SO are trading at forward P/E of 14.8x and 15.7x, respectively, versus the utility sector’s forward P/E of 16.5x .
Summary CEMIG seems very cheap, but faces several easy-to-spot problems. One of those problems is clearly cyclical and temporary. It’s the weather. Beyond a general overview of the issues CEMIG faces and offering a long-term opinion, this article also considers the importance of the weather in trying to establish a CEMIG position. On paper, CEMIG – Companhia Energética de Minas Gerais (NYSE: CIG ) is an extremely appealing equity. Here’s a utility that has a current dividend yield of 10.6% and trades for 4.4x its 2016 EPS consensus. Sure, CEMIG is in Brazil. And Brazil is in the dumper due to an implosion in commodity pricing (namely crude and iron ore), on which its exports long relied. Also, Brazil’s government budget is slowly turning into a deficit, on account of both the economy and higher social spending: (click to enlarge) Source: Tradingeconomics.com, government budget Plus, of course, CEMIG faces its own travails, having lost 3 hydroelectric concessions which are likely to drive its earnings down by ~50% . And then there’s the fact that CIG is an ADR, reflecting the behavior of CEMIG as quoted in São Paulo … in Brazilian Reais. You see, the real has been doing its best impersonation of a banana republic currency – both on account of the commodity implosion, the resulting economic slowdown and the slowly-eroding budget balance: (click to enlarge) Source: Xe.com There is, thus, a lot of trouble to go around. I could however say there’s one bright spot here on the currency front. While the commodity implosion had a very negative impact on exports, the Real implosion made sure that imports fell hard as well. The end result is that Brazil is still holding on to a positive balance of trade: (click to enlarge) Source: Tradingeconomics.com, balance of trade The main economic risk is thus reduced to the chance that the budget deficit deteriorates so much that Brazil resorts to money printing and turns this manageable situation into a Venezuela . Barring that, we could argue that the Real is fairly valued or even undervalued (if some of the commodity weakness in oil and iron ore goes away). At this point, we could thus argue that taking into account the economic outlook, Real, valuation (EPS consensus) and the loss of concessions, CIG should be at an attractive long-term level. And that would probably be right. But there’s yet another factor. The Weather You see, Brazil is supposedly in the midst of its worst drought in the last 80 years ( I , II ). A drought which was made worse by the weak 2014 rain season (starting in November 2014). Now, a drought here is a serious matter, because Brazil relies heavily on hydroelectric power – and CEMIG relies even more on it (though that will now be reduced by the loss of 3 hydro concessions): (click to enlarge) Source: CEMIG Presentation The drought, as I said, was made worse by a weak 2014 rain season. A drought is clearly a temporary factor, so buying stock affected by it could make sense long-term. But usually, you wouldn’t want to necessarily be doing so right away if you thought that there was still significant pain ahead. In that regard, it pays to check how this rain season is going, as it will affect hydroelectric power generation throughout 2016. We do have a way of monitoring how it’s been doing: Source: NOAA, National Weather Service As it were, the answer about the weather is “not so good”. The most important state for CEMIG is Minas Gerais and the adjoining smaller states, and those are clearly seeing under-average rainfall during this rain season as well. Source: Company Presentation So, for timing purposes, we do know that more fundamental deterioration likely still lies ahead for CEMIG even if the present share levels already look attractive for the longer-term. On The Other Hand CEMIG does get a lot of its profits from generation. But it also gets 1/3rd of EBITDA from transmission, and that ought to be defensible: (click to enlarge) Source: Company Presentation This is yet another factor telling us that, longer-term, CEMIG should be attractive – though it probably won’t mitigate further short-term fundamental weakness coming from the weather. Conclusion Some of the problems CEMIG faces are structural, like the loss of 3 important concessions. Others seem discounted, like the massive Real plunge (unless the government goes all Venezuela on us). Taking into account these problems and the earnings impact, it would look like CEMIG is already at an interesting level for longer-term investments (the 2016 EPS consensus puts the company at 4.4x earnings, and should already account for the concession losses – but not for further fundamental deterioration). However, to further refine the timing of buying CEMIG shares, one of the largest problems with CEMIG remains, though it’s clearly cyclical and temporary. I’m talking about the weather. On that front, it looks likely that the fundamental newsflow over the next 3-9 months will remain rather negative – since if it’s not raining a lot right now, it will be hard to compensate for most of 2016. On this account, it might also happen that CEMIG will further cut its dividend or entirely eliminate it (temporarily) – which is another possible “ugly newsflow” event. Putting it all together, CEMIG is trading at an interesting long-term level given the depressed valuation. Weather considerations are mainly for trying to establish the best possible entry point, in spite of the stock already looking attractive long-term.