Tag Archives: income

Reaves Utility Income Fund: What To Make Of The Rights Offering

Reaves Utility Income Fund intends to do a rights offering. Forget about the minutia of the actual offering. Think – instead – about the reason for the offering. Reaves Utility Income Fund (NYSEMKT: UTG ) is one of my favorite closed-end funds, or CEFs, for those seeking utility exposure and dividend income. Its dividend history is nothing short of impressive and it has historically been a solid performer on a total return basis. That said, what should you make of the recent announcement of a rights offering? Impressive record One of the most notable aspects of UTG is its monthly distribution. Since the CEF first initiated a distribution in 2004, it has been increased eight times, most recently in December of last year. The distribution has never been cut, despite the fund living through the deep 2007 to 2009 recession. And, perhaps more impressive, the distribution has never included return of capital. Although the 6% or so distribution yield won’t excite those looking for 10% yields, it’s high enough to be meaningful and yet low enough to be sustainable. History has, so far, proven that out. Performance, meanwhile, is solid. The fund’s trailing 10-year return through September is an annualized 9% or so. That’s notably above Vanguard Utility ETF’s (NYSEARCA: VPU ) 6.6% annualized gain. Both numbers assume the reinvestment of distributions. To be fair, UTG’s mandate is broader than VPU’s, allowing it to invest in areas like oil, but the comparison provides at least a reasonable benchmark. That said, the more recent performance has been, well, not as good. UTG was down roughly 10% through September while VPU was down just 6.6% or so. It has been a bad year for utilities as well as some of the other areas in which UTG invests, so this doesn’t look like it’s an issue of management losing its way. Still, it’s not a good thing to see the value of an investment you own fall 10%. So why is UTG raising cash? Which might lead some investors to wonder why UTG recently announced a rights offering . Shareholders can get one right for every UTG share and buy a new share for every three rights they own. On the surface, this could look like a risky proposition since the fund is doing relatively poorly this year. If you are really cynical you might even suggest it’s a way to cover up a shortfall on the dividend front by spitting out the new cash as return of capital distributions. But step back and think bigger picture. Yes, UTG is doing poorly this year performance wise. Which, in turn, means its holdings aren’t doing so well, since UTG is nothing more than a pooled investment vehicle. If management believes this is an opportunity to buy good companies at depressed prices, its only option is to sell other holdings or raise more cash. But it can’t do that easily because it’s a closed-end fund. Thus, it has to go with a rights offering. In fact, the last time UTG did a rights offering was in 2012 . That was a relatively weak year for the fund, with a total return of around 5.8% compared to 2011’s over 14% gain (which was down from 2010’s 27% gain). In the CEF’s 2012 annual report it explained : “In August the Fund raised $144 million from a transferable rights offering. We view the rights transaction as a long‐term positive outcome for the Fund and its investors. The offering proceeds were invested principally in proven, current holdings of utility equities, increasing their portfolio weighting from just over 41% to 53%. The new investments enhanced the Fund’s current and potential future dividend yield. The outlook, after the offering, for Fund returns over the long term, gave us the confidence to announce in September the sixth increase in the monthly dividend rate since the Fund’s inception in 2004.” Essentially, the fund used the cash raised from the rights offering to buy more companies it knew well and believed were undervalued. It isn’t a stretch to think management is looking to do essentially the same thing this time around, too. If you are a Reaves shareholder this is probably a good deal for you. Will it be a good deal in the next six months? Maybe, maybe not. But longer term the CEF appears to be of the opinion that now is a good time to put money to work. And that should work out for you if you plan to stick around for some time.

Trans-Pacific Partnership Deal: Time For Vietnam ETF?

It looks like time has come for Vietnam to disentangle from the heavy reliance on China as a trading partner. The recently enacted Trans-Pacific Partnership (TPP) trade pact, reached after more than five years of negotiations between the member nations, will make Vietnamese goods reach the global market. TPP is the biggest trade agreement in history aimed at reducing tariffs and setting common trading standards for the 12 Pacific Rim nations, including the U.S., Canada, Japan, Australia, Brunei, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. According to Vu Huy Hoang , Vietnamese Minister of Industry and Trade, TPP will enhance Vietnam’s GDP by $23.5 billion in 2020 and $33.5 billion in 2025. In addition, it will boost the country’s exports by $68 billion in 2025. Currently, TPP member nations represent about 40% of global GDP and 30% of global trade. The deal will open up trading avenues for key export products of Vietnam such as textile, garment, footwear, and seafood in broader market such as the U.S., Japan, and Canada due to their ultra low import tariffs. So far, Vietnam’s trade balance was heavily biased toward China. In the first nine months of the year, China remained the country’s largest trade partner with trade revenues of approximately $50 billion, per Vietnam’s General Statistics Office. However, Vietnam is experiencing weakening demand from China due to its economic slowdown. Therefore, the deal comes at a perfect time. The deal is yet to be ratified by lawmakers in member countries. It is expected to easily pass through Vietnam’s legislature due to its favorable impact on the economy. Vietnam Economy Vietnam’s economy has already been benefiting from low energy costs and very low inflation. Last month, inflation dipped to zero for the first time ever, as per General Statistics Office. Average price gains were less than 1% in contrast to a five-year average of more than 9% till 2014. Lower energy costs led to a 29% rise in new businesses to 68,347 units in the first nine months of the year. Inexpensive labor and devaluation of the Vietnamese dong for the third time in a year by the country’s central bank have also been boosting the country’s exports and attracting foreign investments. Bloomberg data showed that the country’s exports went up 9.6% year over year to $120.7 billion in the first nine months of the year. In the same period, pledged foreign investment soared 53.4% while disbursed foreign investment rose 8.4% from year-ago levels. General Statistics Office estimates revealed that Vietnam’s GDP grew at the fastest pace of 6.3% since 2008 during the first half of the year. The growth is higher than 5.2% in the same period last year and 4.9% in 2013. The government is on track to reach the four-year high GDP growth of 6.2% this year. According to Asian Development Bank, Vietnam is likely to record the fastest growth in 2015 among the five major Southeast Asian countries tracked by the bank. Thanks goes largely to burgeoning private spending, export-led growth and increasing flow of foreign direct investment. Buoyed by the growth potential, World Bank has predicted that Vietnam’s extreme poverty rate (people living under the income level of $1.9 per day) will decrease to only 1% in 2017 from 2.8% in 2012. Moreover, people living under the income level of $3.1 per day are expected to decline to 6.7% in 2017 from 12.3% in 2012. ETF in Focus The TPP deal as well as the recent spate of optimistic economic data definitely turns our attention to the sole ETF focused on Vietnam (nearly 80%), Market Vectors Vietnam ETF (NYSEARCA: VNM ). VNM seeks to match the performance and yield of the Market Vectors Vietnam Index, measuring the performance of stocks listed in the Vietnamese stock index which generate at least 50% of their revenues from within the Vietnamese economy. The ETF holds 32 stocks, mostly from the financial sector (44%), followed by energy (16.3%) and consumer staples (14%). Its top three holdings include Vincom, Bank for Foreign Trade of Vietnam and Saigon Thuong Tin Commercial. The fund has amassed $425 million in assets and trades in a volume of 450,000 shares per day. It charges 76 bps in fees and returned about 8% in the last one month. Original Post

ITC Holdings: For Regulatory Risk-Averse Utility Investors

ITC Holdings is the largest independent FERC-regulated transmission utility with interesting growth opportunities. Even with the potential for lower allowed return on equity, ITC Holdings should generate 20% higher income per investment dollar compared to average state-regulated investments. The current share weakness has caused historical premium valuations to evaporate, creating a great long-term entry point. Morningstar has an interesting take on ITC Holdings (NYSE: ITC ). One key element of utility investing is the relationship between a specific utility’s geographic location and the regulatory environment in which it operates. Nowhere is this relationship more obvious than the current stand-off playing out in state regulatory offices across the country between distributed generation with rooftop solar and its impact on the base-load power generation profile of a specific utility. According to its fact sheet , ITC is an electric transmission company with a federally regulated rate base of $5.2 billion. The Federal Energy Regulatory Agency, FERC, is the rate-setting body for interstate transmission assets, and oversees 100% of ITC’s regulated revenues. ITC is the largest publicly traded transmission company, and operates one of the leading networks with 15,600 miles of high-voltage lines. This differentiator makes the company a unique player in the regulated utility sector. At the core of its lower risk are the higher allowed returns offered by the FERC versus the average state-regulated return on equity ROE. In an effort to draw needed investment capital to expand and upgrade the grid, the FERC has allowed a higher return on equity than the states, on average, have allowed. For instance, since going public in 2005, ITC’s FERC-allowed ROE has fluctuated between 12.1% and 13.8%, while the average state-regulated allowed ROE has been falling. The chart below from Edison Electric Institute plots the average awarded allowed ROE as of June 30, 2015, by quarter. As shown, the average state public utility commission PUC-approved ROE is substantially below those allowed for ITC’s equity investment. The most recent quarterly average from the EEI chart is a 9.73% ROE. The current rate mechanism approved by the FERC allows various ITC subsidiaries to earn the following ROE: ITC Transmission, 13.88%; METC, 13.38%; ITC Midwest, 12.38%; and ITC Great Plains, 12.16%. A comparison of federal versus state regulation is addressed in the most recent investor presentation PDF. The slide below outlines a few of the basic differences: (click to enlarge) Last year, Northeast consumer groups petitioned the FERC to lower its allowed ROE, and after a divisive skirmish, the FERC relented and is reducing allowed returns. The new rate approved for ISO New England transmission assets for ITC should be 11.7%, including a premium allowed for being an independent company. The FERC is under pressure to institute this rate across the country. Even with the potential lower rate, ITC could earn 20% more income from the same investment dollars compared to the most recent average state-approved ROE. This differential is the backbone of the company’s lower risk. From Morningstar’s analysis : “In our opinion, FERC’s formula rate-setting methodology is the most stable and least subject to political influence of any utility regulation in the United States. Therefore, we believe there is little risk of adverse regulatory decisions that would result in allowed returns below the average 10% state-level utilities returns or modify FERC’s favorable regulatory framework. This favorable regulatory framework covers 100% of ITC’s revenue and provides predictable earnings and cash flow. We believe the reduced risk associated with FERC regulation results in a lower average cost of capital than the typical utility.” Recently, its share price has been falling with the rest of the sector. The utility average peaked in January, and has fallen 15% since. ITC peaked in January as well, and has fallen 26% from $44 to its current $32.50. ITC stock has lost a bit of its love from analysts, with the current recommendations being two “Sell,” five “Neutral” and two “Buy.” The concern is based on the reduced ROE potential. However, ITC’s aggressive capital expenditure budget should partially offset lower ROE, driving earnings ahead by 8-12%. Currently, the company is forecast to invest $757 million this year, $852 million next and $818 million in 2017. Over the next three years, ITC’s regulated asset base could grow by over $2.2 billion. This capital expansion will be financed by $1.14 billion in new debt and the balance from internally generated funds. The company generates over $500 million in operating cash flow and pays out $100 million in dividends. Speaking of dividends, ITC recently raised its dividend by 14%, and the payout ratio remains well below the industry average at 38%. Utilities are generally considered to have a low payout ratio if it is below a 60% threshold. Earnings growth is expected to decline a bit to the 8-11% range. However, with a low payout ratio, the company’s dividends could continue to increase substantially above its EPS trend and still be below that of its peers. In an interview with the trade publication TransmissionHub , ITC management discusses two interesting expansion plans. It is proposing the first ever bi-directional connector from Ontario, Canada directly into the PJM grid at Erie, PA. The project is called the Lake Erie Connector, and the high-voltage cable connection would include 73 miles of underwater installation. The project is currently out for bids to potential customers and, if approved, the Lake Erie Connector could cost $1 billion. The second expansion opportunity is a joint venture with NRG Energy (NYSE: NRG ) and a private equity firm to rescue the Puerto Rican electric utility, Puerto Rico Electric Power Authority PREPA. After years of mismanagement, PREPA is on the verge of bankruptcy, driven partially by the need for capital expenditures to upgrade aging power plants to meet new environmental standards. Some generating plants are over 50 years in age and fail miserably in their pollution profile. An article published in Puerto Rico’s main business magazine, Caribbean Business , outlines the $3.3 billion proposed project: “The $3 billion investment would be used to expand PREPA’s existing liquefied natural gas-delivery infrastructure (in the range of $200 million); to bring online new combined-cycle, natural gas-turbine (CCGT) power generation and repower existing PREPA generation (1,200 to 1,500 megawatts [MW]) with investment ranging from $1.5 billion to $1.8 billion, and new renewable generation through solar power (300 to 400 MW) costing nearly $1 billion. The truth is that the coalition brings together three entities that could give PREPA a fighting chance to revitalize its obsolete infrastructure. York Capital, backed by more than $26 billion in assets, has vast experience in restructuring distressed assets; NRG Energy, a $33 billion energy company operates the largest conventional- and renewable-power generation portfolio in the mainland U.S.; and ITC Holdings is the nation’s largest independent electric-transmission company.” Morningstar, as usual, outlines the bull and bear case very succinctly for ITC: “Bulls say: ITC increased its annual dividend by 14% in 2014 and we expect annual increases to average close to 13% during the next five years. MISO expects capacity shortfalls, where the majority of ITC’s assets are located. The generation replacing the coal, mostly natural gas and wind, will require changes to the transmission grid providing substantial new investment opportunity for ITC. Management’s focus on high-voltage electricity transmission should result in better operating efficiency compared with integrated utilities that also have generation and distribution assets. Bears Say: An industrial group has asked FERC to cut ITC’s base allowed return on equity in MISO to 9.15% from 12.38%. An unfavorable outcome would result in lower allowed returns and dividend growth for ITC. ITC Great Plains and ITC Midwest have several competitors proposing transmission system development to move wind power from the Dakotas and Kansas east to load centers. Competition could limit growth opportunities. Several traditional regulated utilities have initiated plans to expand existing transmission or build new lines creating increased competition for ITC.” Below is a F.A.S.T. Graph for ITC going back to its IPO in 2005. Notice both the year-end dividend yield (red line) and the historical P/E (blue line). (click to enlarge) S&P Capital IQ offers a Quality rating for stocks trading longer than 10 years. ITC recently qualified for this evaluation, based on its 10-year history of generating earnings and dividend growth, two important criteria for dividend and utility investors. Company management has generated sufficient consistent growth to qualify for an A+ rating, which is reserved for only about 45 of the 4500 companies followed by S&P. Utility investors looking for a growth stock with high dividend growth potential and a lower regulatory risk profile should review ITC. With the current share price weakness, the company’s historical valuation premium has been reduced to virtually zero, as ITC trades in line with its slower-growth, state-regulated peers at a P/E of 15, when its historical P/E is in the 23 range. In addition, the company has not offered a 2.7% yield since year-end 2008. Now would be a great time to either institute a position or to add to an existing one. 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