Tag Archives: income

NorthWestern Corp. Looks Cheap, But It Will Likely Look Even Cheaper Later

Summary Electric and natural gas utility NorthWestern reported Q2 earnings that beat slightly on adjusted EPS, despite missing big on revenue. The company has expanded its renewable energy capacity in recent years to take advantage of its service area’s abundant hydro and wind resources. The company’s share price has also declined YTD even as its acquisitions have supported its earnings. While NorthWestern’s shares appear to be undervalued, there is a substantial risk that a strong El Nino will reduce hydro output and natural gas demand in its service area. I recommend that potential investors wait for adverse weather impact to provide a more attractive buying opportunity before initiating a long investment in NorthWestern. Northern Plains electric and natural gas utility NorthWestern Corp. (NYSE: NWE ) reported Q2 earnings in late July that beat slightly on EPS despite missing substantially on revenue. The company’s share price has largely declined in 2015 to date after racking up six straight years of steady gains (see figure). Interestingly, the company’s earnings haven’t slowed even as its share price has, suggesting that bearish investment sentiment resulting from a looming interest rate hike by the Federal Reserve is the cause of the latter’s poor performance. NorthWestern has been investing heavily in renewable energy in recent years, acquiring hydro and wind capacity in Montana and South Dakota, respectively. These acquisitions have coincided with falling energy prices and the prospect of weather-related disruptions to supply, however. This article evaluates NorthWestern as a potential long investment in light of these broader macroeconomic and weather conditions. NWE data by YCharts NorthWestern at a glance Headquartered in Sioux Falls, South Dakota, NorthWestern operates electric and natural gas segments that serve utility customers in Nebraska, South Dakota, and Montana. Its electric segment utilizes a mixed portfolio of coal, natural gas, hydro, and now wind to generate electricity that it transmits and distributes to 416,000 customers in all three states. The electric segment has been expanding its renewable generation capacity of late, purchasing 633 MW of hydroelectric capacity in Montana in late 2013 and agreeing to purchase 80 MW of wind power in South Dakota last July. The recent wind purchase, which is expected to close in Q3 with a price tag of $143 million, also includes the rights to a co-located 50 MW expansion site. These acquisitions will allow NorthWestern to easily meet the renewable portfolio standards in Montana and South Dakota, the latter of which is non-binding. Roughly half of the company’s total generation capacity is either renewable or in support of renewable capacity. The company’s natural gas segment transmits and distributes natural gas to 276,000 customers across its service areas. The segment is unique in that it also produces much of the natural gas that it distributes to its customers. It produces enough natural gas to meet 25% of its needs in Montana, for example, and is investigating potential acquisitions in the current low-price energy environment that will allow it to increase this share to 50%. Q2 earnings report NorthWestern reported Q2 revenue of $270.6 million, up 0.1% YoY and missing the analyst consensus estimate by a substantial $45.8 million (see table). The company attributed its low numbers to the presence of warm weather during the cold part of the quarter, which reduced its natural gas retail volumes by 14% compared to the previous year despite an increase to its customer numbers over the same period. Higher temps were prevalent across its service area, with the company reporting 16% fewer heating degree-days in total. These factors ultimately caused the natural gas segment’s revenue to decline by 15% compared to the previous year. The electric segment offset some of this decline, reporting a 7.5% YoY increase to its own revenue on higher retail rates and customer numbers. NorthWestern Corp. financials (non-adjusted) Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Revenue ($MM) 270.6 346.0 312.9 251.9 270.3 Gross income ($MM) 191.0 233.6 204.9 157.3 157.8 Net income ($MM) 31.0 51.4 37.2 30.2 7.8 Diluted EPS ($) 0.65 1.09 0.85 0.77 0.20 EBITDA ($MM) 97.9 119.7 88.7 61.0 55.5 Source: Morningstar (2015). The company’s gross income came in at $191 million, up from $158 million YoY, as its cost of revenue declined by more than revenue on lower energy prices (see figure). The natural gas segment reported a 9.4% YoY decline to gross income, as the presence of reduced demand and its reliance on own production to meet much of this demand limited the decline to cost of revenue. This was more than offset by the electric segment, however, which reported a 31% YoY increase to its own gross income. Much of this increase was the result of generation from its Montana-based hydroelectric capacity showing up on its income statement; the segment’s gross income remained flat if this income source was excluded. The segment’s gross margin (gross income/operating revenues) did increase from 58% to 71% over the same period, however. Henry Hub Natural Gas Spot Price data by YCharts NorthWestern’s net income rose to $31 million from $7.7 million in Q2 2014, resulting in a diluted EPS of $0.65 versus $0.20. Much of the increase was the result of an insurance settlement payout, without which the company’s net income was $23 million on an adjusted basis versus $9.8 million YoY. Adjusted diluted EPS came in at $0.48, up from $0.25 over the same period and slightly beating the consensus estimate of $0.45. The company increased its quarterly dividend by 20% to $0.48 on the strength of its performance (resulting in a 3.8% forward yield), which also saw its free cash flow increase to $26.3 million from -$48.0 million YoY. Finally, management also took advantage of a favorable interest rate environment to refinance $150 million of debt due in 2016 with $200 million of 10- and 30-year mortgages at a substantially lower rate. Outlook NorthWestern’s decision to add wind capacity should prove to be a smart investment moving forward. The North Plains is one of the windiest places in the U.S. on a sustained basis (see figure) and has been home to much of the nation’s rapid wind farm growth over the last decade as a result despite its plentiful access to cheap natural gas and small population. The company’s service area overlaps with abundant wind resources and I wouldn’t be surprised to see it take advantage of the additional 50 MW capacity option in the event that Congress extends wind’s Production Tax Credit. Wind energy has been one of the few resources to prove competitive with fossil fuels in recent years and NorthWestern has additional backup natural gas capacity available to support such an expansion. In the shorter term, it remains to be seen how accretive the acquired capacity will be to the company’s earnings, as this will ultimately depend on South Dakota’s rate case decision that is due by the end of 2015. Source: EIA (2012). The company is also pursuing $100 million of additional natural gas investment so that it can supply 50% of the natural gas that its customers in Montana consume. It expects to incur roughly $1.5 billion in additional capex through the end of 2019 that will support future rate increases. The majority of these expenditures will be spent on infrastructure maintenance and upgrades. One area that investors should keep an eye on is the state of the economy in the company’s service area. The large fall to the price of energy that has occurred across the board since the second half of 2014 has negatively impacted the Northern Plains’ economy in the form of higher unemployment rates (see figure), which has benefited in recent years from the exploitation of unconventional fossil reserves. While NorthWestern’s customer numbers have yet to reflect this recent weakness by declining, multiple quarters of low energy prices could ultimately cause these numbers to plateau or even fall, offsetting some or all of the positive impact of rate increases on the company’s earnings. Montana Unemployment Rate data by YCharts Weather factors present the largest headwinds to NorthWestern’s earnings over the next few quarters, however. The West Coast drought that has been capturing headlines over the last year has also been appearing as far east as Montana. As of this month the western half of the state is classified as either “Moderately Dry” or “Severely Dry”, while much of the eastern half of the state is classified as “Slightly Dry.” Management stated during the Q2 earnings call that the drought conditions weren’t affecting its hydro operations in the state yet due to the fact that its capacity is widely distributed across the state. The drought conditions are of concern, however, because they are likely to grow worse over the next two quarters. NOAA recently announced that an especially strong El Nino is developing and, given its magnitude, it is now expected to last through the spring. Past El Nino events have resulted in reduced precipitation in Montana, as the winter storm track has been pushed into the south half of the U.S., with levels falling to an average of 75-80% between November and March of those experienced in normal years (see figure). Reduced river levels resulting from lower snowpack development can cause hydro generation to fall sharply, much as is already occurring in California. This, in turn, leads to higher average variable power costs that limit EPS, especially if not offset by higher rates. Source: NOAA . Compounding the potential impact of El Nino on Montana’s hydro generation this winter and spring is its impact on winter temperatures in NorthWestern’s service area. Past El Ninos have resulted in higher-than-normal temperatures in Montana, South Dakota, and north Nebraska, reducing the number of heating degree-days experienced during the winter and early spring. Montana has historically experienced the warmest temperature increases during El Nino events, especially in Q1. The impact of El Nino on NorthWestern’s earnings could be significant, as Q4 and Q1 have historically been when the company has earned the large majority of its annual earnings (see figure). Weak winter and spring demand for natural gas resulting from a historically strong El Nino would likely cause the company’s earnings to fall on a YoY basis, especially if it coincides with higher average variable power costs resulting from reduced hydro generation. NWE EPS Diluted (Quarterly) data by YCharts Valuation The consensus analyst estimates for NorthWestern’s earnings have remained relatively flat over the last 90 days. The consensus an analyst estimate for diluted EPS in FY 2015 has fallen slightly from $3.17 to $3.16 while the estimate for FY 2016 has increased slightly from $3.38 to $3.41. Based on a share price at the time of writing of $50.80, the company’s shares are trading at a trailing P/E ratio of 19.2x on an adjusted basis and forward ratios of 16.1x and 14.5x, respectively. The forward ratios have fallen significantly since peaking at the beginning of the year and are approaching multi-year lows (see figure). Even accounting for bearish sentiment on utilities resulting from a likely interest rate hike by the Federal Reserve before the end of the year, NorthWestern’s shares appear to be undervalued at present on the basis of the consensus analyst earnings estimates. That said, the estimates for FY 2016 in particular have not fallen over the last 90 days even as meteorologists have increased the expected strength and duration of the El Nino event in Q4 2015 and Q1 2016. NWE PE Ratio (TTM) data by YCharts Conclusion NorthWestern Corp. reported Q2 earnings that beat slightly on EPS despite missing big on revenue. The news briefly interrupted a steady decline to the company’s share price, although it has since re-approached its YTD low. Meanwhile, the company’s earnings have marched steadily higher, as it has invested in new capacity while also benefiting from reduced energy costs, resulting in share valuations that are approaching multi-year lows. While it is tempting to recommend the company as a long investment on those grounds alone, potential investors should be aware that meteorologists expect this year’s El Nino to be historically strong through spring. Historically, weather conditions in the company’s service area have been both warmer- and drier-than-normal during past El Nino events, indicating that there is a strong likelihood that both hydro output and natural gas demand will be reduced during the important Q4 2015 and Q1 2016 earnings periods. I encourage potential investors to wait for potentially disappointing earnings in the coming quarters resulting from adverse weather conditions to provide a better buying opportunity.

MORT And MORL Weighed Down By Smaller MREITs In 2015

Summary Despite their high yields, MORL and MORT have recorded negative total return performances in 2015. Surprisingly, the top 7 holdings of the fund all posted better YTD returns than the index. A number of smaller mREITs have fallen > 20% this year and may offer attractive entry points for the aggressive investor. Investors in the Market Vectors Mortgage REIT Income ETF (NYSEARCA: MORT ) and the 2x leveraged version, the UBS ETRACS 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ), have not had a good year so far. Despite a recent rally triggered by the Fed’s decision not to raise interest rates, MORT is still down by -5.39% year-to-date [YTD], while MORL is down -12.5%. The iShares Mortgage Real Estate Capped (NYSEARCA: REM ), an ETF that tracks a different index than MORT/MORL, has performed slightly better at -4.00% for the year. MORL Total Return Price data by YCharts As an investor in MORL, I wanted to find out why the fund was doing so poorly. I first checked the YTD performance of Annaly Capital (NYSE: NLY ) and American Capital Agency (NASDAQ: AGNC ), the two largest constituents of MORT/MORL that together constitute nearly 25% of the index. However, neither stock has done as poorly as MORT. NLY has eked out a positive return of 1.89% in 2015, while AGNC is down by -3.41%. NLY Total Return Price data by YCharts I then checked the performance of the five next-largest constituents of MORT/MORL. Surprisingly, these five stocks have also all outperformed MORT. New Residential Investment Corp (NYSE: NRZ ) leads the pack with a YTD total return performance of +19.46%. STWD Total Return Price data by YCharts Summarizing the observations so far, the seven-largest holdings of MORL/MORT, which account for over half of the fund, have all outperformed the index. This suggests that the remaining constituents of the index have underperformed. To investigate this further, I obtained the weightings and YTD performance data of the 24 constituents of MORT/MORL from Morningstar . Note that the total return data may differ slightly from the YCharts graphs above. For the rest of the article, the Morningstar data will be used. Company Ticker % Assets YTD return / % Annaly Capital Management Inc NLY 14.70% 1.94% American Capital Agency Corp AGNC 10.21% -3.23% Starwood Property Trust Inc STWD 6.20% -2.28% New Residential Investment Corp NRZ 5.40% 22.32% Chimera Investment Corp CIM 5.37% -3.58% Two Harbors Investment Corp TWO 5.24% -0.10% Blackstone Mortgage Trust Inc BXMT 5.22% 3.47% Mfa Financial Inc MFA 4.42% -5.26% Hatteras Financial Corp HTS 4.36% -6.78% Colony Financial Inc CLNY 4.33% -5.00% Invesco Mortgage Capital Inc IVR 4.22% -6.14% Cypress Sharpridge Investments Inc CYS 3.95% -3.90% Pennymac Mortgage Investment Trust PMT 3.75% -17.88% Capstead Mortgage Corp CMO 3.12% -9.93% Apollo Commercial Real Estate Finance I ARI 3.02% 7.70% Armour Residential Reit Inc ARR 2.83% -21.81% American Capital Mortgage Investment MTGE 2.58% -6.61% New York Mortgage Trust Inc NYMT 2.58% -12.05% Redwood Trust Inc RWT 2.24% -20.96% Anworth Mortgage Asset Corp ANH 1.57% 2.86% Resource Capital Corp RSO 1.46% -27.83% Rait Financial Trust RAS 1.26% -22.82% Dynex Capital Inc DX 1.15% -14.79% Newcastle Investment Corp NCT 0.98% 13.59% The results above confirm my initial suspicion. While the top 7 holdings in the index (together accounting for over 52% of assets) had an average YTD performance of +2.65%, the remaining 17 constituents had an average performance of -9.27%. The data above is also shown in graphical form. There is weak positive correlation between % assets and % YTD return, indicating that the largest mREITs have outperformed the smaller mREITs so far this year. (The index uses a cap-weighted methodology, meaning that mREITs with a greater weighting in the index have larger market caps). The data is also shown in bar chart form below. We can see that most of the worst-performing mREITs lie on the right hand side of the chart, i.e. the big losers have all been smaller-cap mREITs. A notable exception is NCT, which is the smallest holding in the index but recorded a +13.59% YTD gain. Implications for investors What does this mean for mREIT investors? Firstly, we can see that there is a very wide dispersion in YTD return performances. NRZ has the best total return performance of +22.32%, while RSO has had the worst total return performance of -27.83%. However, past performance is no guarantee of future results, and investors uncomfortable with picking individual mREIT names may still prefer to remain diversified by investing in MORT/MORL. MORT has a trailing 12-months [TTM] yield of 11.07% and MORL has a TTM yield of 29.23%. Secondly, it is unclear whether the outperformance of large-cap mREITs vs. their small-cap brethren will persist into the future. The constant jitters and palpitations over a potential rate hike in 2015 may have unfairly punished small-cap mREITs, which are probably deemed to be more risky and volatile compared to their larger peers. However, this is just my rough guess, and more knowledgeable mREIT investors may have a better answer to this conundrum. A full analysis of the effect of interest rates on the performance of each mREIT is beyond the scope of this article. Finally, I hope that investors who are comfortable with selecting individual mREITs may still find the data useful. With further potential interest rate turmoil ahead, does one stick with the industry bellwethers NLY and AGNC which have weathered the storm so far in 2015? Or does one go bottom fishing with small-cap mREITs such as ARR, RWT, RSO and RAS that have all fallen more than 20% YTD, with the hopes of a rebound? The answer will depend on each investor’s risk appetite and interest rate outlook. Disclosure: I am/we are long MORL. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

National Grid Offers Both Capital Appreciation And A Steady Stream Of Dividends

Summary Utility companies are usually in the spotlight whenever dividends are mentioned. National Grid is one of those rare companies that offers a steady dividend stream and a slice of capital appreciation for investors. With a footprint in the U.K. and U.S., this company has a very extensive network of transmission wires and gas pipelines. The company’s financial position definitely warrants a consideration for investors who are in search of both security and income. This hidden gem has been missed out by the majority of the market. Investors who come on board today stand to profit greatly. Introduction With what is happening lately in the market, it is very easy to get distracted by all the noise that is surrounding the business world and lose track of the great businesses that are serving people. As I combed the market for bargains, I picked up on one that will not only offer investors a good return on its capital appreciation but also delivers a steady and growing dividend. National Grid (NYSE: NGG ) is just that kind of a company. This is a business that has a solid balance sheet and is delivering a steady stream of cash flow to investors. Business Overview National Grid owns electric transmission wires and gas pipelines. Its stock offers a better risk to return proposition for the long-term investor. Most investors in today’s market would prefer a stock that dishes out a 5% dividend, brings about a moderate amount of risk and the chance to profit on capital appreciation as uncertainty plagues the global market. The company’s competitive advantage lies largely in its extensive network of transmission wires in the U.K. and Northern U.S. Although this business sounds like a typical utility company, there is more than meets the eye for investors as the company starts to dig deeper into what it owns and how it operates. Transmission and Distribution National Grid functions coordinates and enables the flow of electricity in both England and Wales but not in the U.S. Consumers simply pay a fee to the company in order to have the rights to use the system. This revenue structure enables National Grid’s income to be not only very stable but also predictable. Although it does not possess the toll-like characteristics in the U.S., the company has some very valuable assets and serves nearly 4 million customers. Transmission grids are often linked to one another so that electricity can flow from one state to another. Right now, the company is planning on expanding its network into Iceland, Belgium and other parts of Europe as well. As the assets of the company grow, it will be able to fetch more revenue which will allow it to expand even more, and the positive cycle repeats itself. In the U.K., National Grid owns and operates the National Transmission System, which is a gas infrastructure. The company has a distribution network that serves at least 11 million customers, along with a collection of liquefied natural gas importation terminal and storage facilities. Despite being known by many as a utility company that generates power (with the exception from the power plants in New York), National Grid earns a buck whenever power is being transmitted through the lines it owns. This toll-like business model should give investors seeking a predictable return some comfort and certainty as the majority of risk is now shifted to the power producers. What investors need to keep in mind is that much of its transmission grids are wearing out and it is almost time for the company to reinvest and repair its infrastructure. Knowing that this would be a very capital-intensive project, the company charges a high price to consumers so as to generate sufficient revenue to finance new projects and repair old ones. Most of National Grid’s revenue is fixed and dependent on the amount of assets we are looking at here. As the business and its infrastructure grows, so will the predictable stream of income. As the energy arena keeps progressing, changes are blind to happen. The U.K. has determined that utilities would need at least $300 billion in order to keep up with that change. The company has laid out an 8-year plan to invest in its assets and currently, it is in the second year of that plan. As a result of this, the company is expecting that its regulated assets will grow by approximately 5% to 6% in the U.K. over the next few years. I think that the company has made a wise move in investing in its U.K. assets as it churns the lion’s share of its operating income. In the U.S., the company is upgrading its gas and electricity systems and that will ensure that it will keep turning a steady stream of profit in the long run. Financial Position If one were to look at the balance sheet of any utility company, he or she would realize that it is more or less the same in terms of the amount of debt it has and the margins it generates. Over the coming years, I would not expect to see a drastic change in finances for the company. With expansion plans on the line, the company should be able to grow steadily at a low single-digit pace. Lastly, the dividend would likely hold steady and shareholders can sleep well at night as the company will continue to dish out dividends with a 5% yield. Potential Short Circuit In a utility business, there are two key factors investors need to keep an eye on to know whether or not the company is able to scale: demographic growth and regulation. In terms of demographic growth, it isn’t very robust in either U.S. or the U.K. On the regulatory aspect, the relationship between National Grid and regulators isn’t a bad one. However, if the relationship sours, investors might have a reason to worry. For now, investors can remain comfortable as the business is financially strong and that it can withstand the market’s volatility. Over the long run, I do not foresee people using lesser electricity. Even if solar power was to come into play, it would still require the grid and transmission lines (to a certain extend) to run on. I believe the company has ample time to adjust to the changing market and temporary hiccups should not cause a knee-jerk reaction for long-term investors. Conclusion In a market where interest rates are almost negligent, most investors would be thrilled to find a company that yields a 5% dividend while offering a chance for capital appreciation at the current price. I would recommend investors take a close look at National Grid and see how it can charge up your portfolio. Disclosure: I am/we are long NGG. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.