Tag Archives: income

A Warm Winter Forecast Provides Downside Risk For CMS Energy

Michigan electric and natural gas utility CMS Energy recently reported Q3 earnings that beat on EPS despite missing slightly on revenue. The company’s earnings report and earnings call were largely upbeat despite the presence of underwhelming demand growth from its overall customer base. Low energy prices will make it possible for the company to maintain earnings growth via higher capex without negatively affecting customer demand via the imposition of higher rates. The company’s shares are overvalued relative to historical valuations, however, even as a strong El Nino is likely to result in a warm winter across its service area. Investors are advised to refrain from initiating a long position in CMS Energy until its share valuation provides them with a larger margin of safety. Michigan electric and natural gas utility CMS Energy (NYSE: CMS ) reported Q3 earnings last month that beat on diluted EPS despite missing slightly on revenue. Revenue came in at $1.5 billion, up by 4.2% YoY but missing by $60 million. Diluted EPS came in at $0.53, missing the analyst consensus estimate by $0.04 and improving from $0.34 YoY. The third quarter is historically one of the company’s weaker periods due to the seasonal presence of mild weather in its service area, however, and the earnings beat only prompted the company to slightly tighten its earnings guidance for FY 2015. The company’s share price has fallen by 3% in the aftermath of the earnings report’s release, although this volatility is likely the result of shifting expectations regarding the Federal Reserve’s upcoming interest rate hike. In a June article on the company I wrote that the interest rate increase would likely cause its share price to decline to $30 from price of $31.59 at the time of writing, although its longer-term growth potential was robust due to a rebounding economy in its service area. Weak U.S. economic indicators caused the Federal Reserve to delay the rate hike, however, resulting in a broad rally in the utilities sector that pushed CMS Energy’s share price as high as $37, although profit-taking and renewed rate hike fears have caused it to settle during the subsequent three weeks. Much of the company’s Q3 earnings report and subsequent earnings call focused on its ability to grow over the next several years by way of capex rather than increases to its customer numbers. One unique strategy that the company is envisioning is to take advantage of the lower natural gas prices that are being passed onto consumers via lower rates by investing heavily in infrastructure upgrades. While the capex would normally be passed onto consumers in the way of higher rates, in this case the impact of the increase would be offset by the effect of lower energy costs. In this way the company could make the investments to its infrastructure that are needed to maintain service reliability without causing rates to rise to the point that customers reduce their consumption in response. Implementation of this tradeoff will require the permission of regulators, although the company is strongly arguing its case. It is important to note that capex growth is expected to be the primary driver of earnings growth moving forward in large part due to a lack of consumption growth in CMS Energy’s service area. While Detroit’s economy in particular has been rebounding following the resolution of its financial crisis, this has yet to translate into demand growth by the utility’s residential and commercial customers. In fact, demand growth by its industrial customers is the only thing keeping the company’s overall demand growth forecast in positive territory over the next year. Barring an unexpected recession in the U.S. this industrial demand is unlikely to worsen, but investors should be aware of the sensitivity of the company’s demand growth forecast to industrial demand. That said, I have grown bearish on natural gas demand by the company’s residential natural gas customers, in particular due to the strong arrival of this year’s El Nino weather event. This year’s El Nino is, as was predicted earlier in the year, already showing signs of being one of the strongest on record. What is expected to be a boon for southern utilities will, counter-intuitively, likely be a detriment for their northern counterparts. Previous El Nino events have been associated with warmer and drier weather across Michigan, including CMS Energy’s service area, between October and April. A similar occurrence in Q4 2015 and Q1 2016 will result in reduced natural gas and, to a lesser extent, electricity demand by the company’s residential customers in particular (industrial customers, on the other hand, tend to base their consumption on facility online time rather than the weather). While not as important to its earnings as electricity sales, a plus-or-minus 5% change to annual natural gas sales has a corresponding plus-or-minus $0.07 change to annual EPS. Furthermore, the company’s natural gas sales tend to be highest in Q4 and Q1, meaning that this sensitivity is likely to be higher still over the next two quarters. An especially warm winter, then, has the potential to noticeably reduce the company’s earnings. The consensus analyst estimates for CMS Energy’s earnings in FY 2015 and FY 2016 have remained steady over the last 90 days, the former actually increasing slightly, despite the growing likelihood of reduced natural gas demand in its service area that has developed over the same period. The company’s trailing and forward P/E ratios remain quite high relative to their historical ranges at 19x and 18.8x, respectively, leaving investors with a minimal margin of safety in the event that this year’s El Nino event is a drag on the company’s Q4 2015 and Q1 2016 earnings. The earlier strength of its share price notwithstanding, then, potential investors are advised for a larger margin of safety to develop before initiating long positions in CMS Energy. The company’s current valuation is simply too high given the downside risks posed by a warm winter and looming interest rate increase.

The 4 ETFs That Will Replace My Portfolio’s Core

Summary All of the ETFs mentioned have annual expenses under 0.15%. The ETFs mentioned will allow broad based diversification for my portfolio’s core. These offerings are from Vanguard, but several other low cost fund families exist. Nearly two years ago I wrote an article entitled My Retirement Portfolio Could Be Replaced With These 5 ETFs . At the time, the article was written basically to as an alternative concept to my portfolio (at that time) of individual stocks. We all tend to evolve as investors over time. Each of us are on our own journey, whether we’re talking about investing or life in general. I know the focus of my life has evolved over the past few years. If you are interested in a summary my family’s journey thus far, read about it HERE . Over the past 2 years I have come to two important realizations, which encourage me to eventually rotate mostly out of individual stocks and to the portfolio outlined below. First and most importantly, there simply aren’t that many companies around the world that deserve my family’s capital. To be clear, I don’t mean there aren’t some reasonable values in the global equity markets. I am talking about companies that are so well run, and have amazingly sustainable competitive advantages, that I would commit to owning these companies for the next 20 or 30 years. Perhaps you think the idea of holding an investment for decades is a simplistic and illogical consideration, but I contend that it’s exactly my intention when I invest in an individual company on the “long-term side” of our bifurcated portfolio . For that reason, in the future I will cap individual stock investments at 25% or 30% of our portfolio’s value. It will be limited to companies that can compound my capital, and unlock value, for decades and I think those are few and far between. The second consideration in proposing the portfolio outlined below, is my personal time commitment . Currently I have a day job and enjoy researching our individual stock investments, but we are moving toward semi retirement. I anticipate additional flexibility and travel in semi retirement, but I can’t allow the time commitments of monitoring a portfolio of individual stock investments to get in the way our flexibility/freedom. That sounds too much like work. With those two considerations in mind, let’s take a look at the ETF offerings below. (Note: the funds discussed are all Vanguard offerings, but there are also other low cost fund families to consider like Fidelity and T. Rowe Price. Vanguard Total Stock Market ETF (NYSEARCA: VTI ) First up is Vanguard’s Total Stock Market ETF, my proxy for exposure to domestic US companies. In the previous article I mentioned Vanguard’s S&P 500 ETF (NYSEARCA: VOO ). Several readers commented that Vanguard’s Total Stock Market ETF might be a better alternative, because it includes both small and mid capitalization companies. After some thought, I agree. While this ETF is capitalization weighted, which in this case means it’s heavily skewed toward the large cap companies of the S&P 500, it also gives me some exposure to the small and mid capitalization companies. I like the concept of this additional exposure, because the small and mid capitalization companies tend to be much more isolated from international troubles and get nearly all of their business within the United States. I like to think of this ETF as the S&P 500, with a little extra kick. Given so much diversification, it’s hard to beat the annual expense ratio of 0.05%. Below is a snap shot of Vanguard’s Total Stock Market ETF, from Vanguard’s website. The companies in the portfolio represent a wide variety of industries. (click to enlarge) Vanguard FTSE All World ex US ETF (NYSEARCA: VEU ) The next ETF would be Vanguard’s FTSE All World ex US ETF. This fund includes stock in more than 2500 different companies around the world. The holdings are skewed to the largest capitalization companies, because of the fund’s capitalization weighting. Also as a result of the fund’s weighting, you probably recognize all of the names in the top 10 portfolio holdings. (Think Nestle ( OTCPK:NSRGY ), Royal Dutch Shell (NYSE: RDS.A ), Toyota (NYSE: TM ), and Unilever (NYSE: UL )). In the graphic below, courtesy of Vanguard’s website, you can see that this truly is a global fund. This is the type of diversification I expect from a capitalization weighted all world fund. Additionally, if you don’t feel comfortable having a large weighting of emerging market companies in your portfolio you may be able to hit your desired asset allocation within the 17.5% of this fund that represents companies located in emerging market economies. The annual expense ratio of this fund is only 0.14%, which is paltry considering the diversification (and rebalancing efforts) achieved by owning this fund. (click to enlarge) Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) If you are optimistic about the future of emerging market economies, you may want to add additional exposure to your portfolio by including something like Vanguard’s FTSE Emerging Markets ETF. I own this fund, but be warned that everyone has a different definition of what an “emerging market” economy is. Some people think of frontier economies, like those found in Africa and the Middle East. Others think of countries like Brazil, Russia, India and China. I’m not here to tell you what the right answer is, but remember that some emerging market economies have been “emerging” for decades. Remember to dig into your fund’s portfolio allocation, to be sure you are comfortable with what you are buying. (click to enlarge) See the table below for a perfect case in point. This is the geographic distribution of Vanguard’s FTSE Emerging Market ETF. A full 28.2% of the portfolio is comprised of businesses based in China, and 55.3 percent of the portfolio’s companies are based in China, Taiwan, or India. I would prefer if the percentage of companies from those three countries was reduced somewhat, but overall I feel the diversification achieved by this fund fits my family’s needs pretty well. For my annual expense ratio of 0.15%, I gain exposure to over 2500 different global companies. As a result of the difficulty gathering quality corporate information in many of these emerging economies, I have always used an ETF (and this one specifically) to purchase my desired allocation of emerging market companies. Vanguard Total Bond Market ETF (NYSEARCA: BND ) There is a conversation raging right now about whether or not bond investors are being adequately compensated for the risks present in the bond market. That’s a conversation for another day, although I will note that because I am still in my 30s and interest rates are so painfully low, I have not had any meaningful bond exposure in my portfolio for several years. Clearly this is an individual decision, and every investor is different. If however you would like exposure to more than 7700 bonds, for an annual expense ratio of 0.07%, Vanguard’s Total Bond Market ETF may be for you. As you can see in the three tables below, courtesy of Vanguard’s website, the vast majority of holdings are highly rated bonds. The bonds held in the portfolio are also from a variety of issuers and of varying duration. For simple and straight forward bond market exposure, Vanguard’s Total Bond Market ETF is worth a look. Specialty (Sector, County, and Asset) ETFs It’s amusing sometimes to look at all the different specialty ETFs and mutual funds currently being offered. While the typical investor has no need to invest in many of these funds, they are available if the investor so decides. Two specialty funds that come up in my conversations with readers are listed below, but rest assured that your own imagination is the only limit of fund offerings. If you want to invest in a socially responsible fund that only invests in women owned businesses in the former Soviet Union states, I’m sure there is a fund out there for you. I’m exaggerating to prove a point, but I assure you that there are literally thousands of specialty funds available to you, if you take the time to look for them. Remember that just because these funds exist, doesn’t mean they are worthy of your hard earned capital. Vanguard REIT ETF (NYSEARCA: VNQ ) In the current low interest rate environment, investors have been searching for yield anywhere they can get it. Many investors have turned to corporate dividends and distributions from REITs (real estate investment trusts) or MLPs (master limited partnerships). If you are interested in owning a basket of REITs, Vanguard’s REIT ETF may be for you. For a 0.12% annual expense ratio, you gain exposure to 140+ different REITs. In the graphic below (courtesy of Vanguard’s website) you can see the sector diversification offered within the fund, as well as the top ten fund holdings. (click to enlarge) Vanguard Healthcare ETF (NYSEARCA: VHT ) Many investors are keen to take advantage of long term trends, such as aging demographics, and global healthcare issues. If you are looking for this type of exposure, Vanguard’s Healthcare ETF is worth a look. For a low 0.12% annual expense ratio, you can gain exposure to over 330 companies within the healthcare industry. The distribution of those companies is shown in the graphic (courtesy of Vanguard’s website) below, as are the funds top portfolio holdings. (click to enlarge) In a future article I will write about my asset allocation goals for my portfolio, but I hope this article gave you an idea of several very sold ETFs offered within the Vanguard family of funds. (Other low cost fund families you may want to look at include Fidelity and T. Rowe Price). Given the impressive returns posted by equity markets around the world, I have been hesitant to shift all of our holdings over to passive index ETFs just yet. The reality is that I currently enjoy researching and picking individual stocks. Eventually I will not have the time, or desire, to spend so much time on our investments. At that time, having a core portfolio position in the group of ETFs mentioned here will be my best bet. I took an early step in that direction this summer, following China’s massive sell off, when began accumulating a large position in Vanguard’s Emerging Markets ETF. I still have a long way to go before I reach my desired asset allocations, but I am optimistic that better investment opportunities (and lower prices) will present themselves in the future. Do you hold index funds or ETFs in your portfolio? Why or why not? Disclosure: The only ETF mentioned that I currently own is VWO. I do own individual stocks included in some of the other ETFs. Please consult your investment professional to create an asset allocation mix that meets your specific needs. Mine is a fairly unusual case given my young age and mix of investment holdings. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any securities. I am not a financial professional. The information above is available at Vanguard.com.

Some Prefer Southern Company Over Wisconsin Energy: I Just Don’t Get It

Summary I recently published a follow- up article about Wisconsin Energy after the acquisition of Integrys. Several friends told me that I should prefer Southern Company over Wisconsin Energy. They claim that the superior yield is due to some short term hardships that will soon be over. I totally disagree, I believe Wisconsin Energy is by far a superior investment. I will now try to explain why. Introduction A week ago I wrote this article about Wisconsin Energy (NYSE: WEC ). In the article, I tried to analyze the company after the acquisition of Integrys (NYSE: TEG ). The article is really in favor of buying the shares of the company. Several friends told me after reading the article that I should prefer Southern Company (NYSE: SO ) over Wisconsin Energy. They claim that the superior dividend yield and the longer streak of dividend raises make it a superior investment for dividend growth investors. They believe that currently, the company suffers from short-term headwinds. I read a lot about Southern Company and I totally disagree. In this article, I will show the fundamentals and valuation of the company, and then show a comparison with Wisconsin Energy, that I believe will allow me to emphasize the superiority of Wisconsin Energy over Southern Company. Southern Company through its subsidiaries, Alabama Power Company, Georgia Power Company, Gulf Power Company and Mississippi Power Company, supplies electric service in the states of Alabama, Georgia, Florida, and Mississippi. Each of those subsidiaries is an operating public utility company. Additionally, Southern Company owns all of the common stock of Southern Power Company, which is also an operating public utility company, which constructs, acquires, owns, and manages generation assets and sells electricity at market-based rates in the wholesale market. Fundamentals Southern Company has terrible fundamentals, really, it is hard for me to describe it otherwise. The revenues for example grew from $13.554 in 2005 to $18.467 in 2014. This is CAGR of 3%, which might be reasonable if the income is growing at least at the same pace. Yes, it is a utility company which doesn’t show fast growth, but I still have higher expectations. SO Revenue (NYSE: TTM ) data by YCharts EPS growth is even worse, when thinking about the EPS growth together with inflation, well there is practically none. The EPS grew from $2.13 in 2005 to $2.18 in 2014. This is CAGR of 0.23%, which is practically no growth, and when taking inflation into consideration, it is practically declining. Let’s look now towards the future. The analysts’ estimates are for growth of 2.5%- 3% in EPS for the next 3- 5 years. Having said that, I am not happy with the EPS growth in the past and the future estimates. SO EPS Diluted (Annual) data by YCharts The dividend is another weak fundamental in my opinion. The annual payment grew from $1.49 in 2005 to $2.1 in 2014. That is CAGR of just 3.5%. As you read above, as EPS is flat, the dividend rose by expanding the payout ratio. This is not sustainable for the long run, and therefore it makes me worry about the ability of the company to show real growth. In 2014, the payout ratio was over 95%, and even for the estimate for 2015, the payout ratio will be over 75% which is high for utilities. Currently, the company yields just under 5%. I don’t think the yield is high enough to justify such slow growth. SO Dividend data by YCharts Usually I like it when companies reward shareholders by using big parts of the FCF for dividends and share repurchases. However, with such a high payout ratio, I didn’t expect Southern Company to buy its own shares. Yet, I figured out that not only that the number of shares didn’t decrease, it actually rose by over 22% over the past decade. I don’t mind being diluted when smart acquisitions are made like the acquisition of Integrys by Wisconsin, or by the purchases of new properties by Realty Income (NYSE: O ). In these cases the dilution is used to grow EPS and FFO. In this case, the dilution comes with low growth. Not my cup of tea. Valuation When I look at the valuation of Southern Company, I find a company that is valued cheaper than Wisconsin Energy. The difference in the valuation makes perfect sense as Wisconsin Energy is growing its EPS while Southern Company has stagnated. In my opinion, the difference isn’t big enough. I find Wisconsin Energy fairly valued for a company that will grow at around 6% every year. By looking at the forward P/E for this year and the year after, I can see that the gap is becoming smaller and smaller. As a long term investor, it is hard for me to justify purchasing Southern Company at the current valuation. SO PE Ratio ( TTM ) data by YCharts The lower valuation is not low enough for me to consider Southern Company at the moment. It might sound odd, but I find it overvalued when compared to other high yielding companies, with slower than average growth. Risks As I see Southern Company, there are two main risks to this investment. The first one is the lack of growth catalysts. The company is forecasted to grow its earnings by less than 3% annually over the next several years. This is very low even for a utility company, especially one that expanded its payout ratio so much. The company must find new ways to grow its income and revenues. The second risk is the still increasing expenses of the Kemper project in Mississippi. This project consumes more and more money, and it takes a big part of the cash flow as it increases the capex. In 2014 alone, the expenses on this project cost the company $0.83 per share. Southern Company will have to invest more money in order to finish it. Finishing it will indeed free some if its cash flow, but it will still not be able to serve as a real growth catalyst. Opportunities Southern Company still has several opportunities, but I find them pretty vague. Firstly, most major expenses on the Kemper project are behind us already. The necessary investment will now be much lower, and it will allow the company to use the money in a better way. Another opportunity is the fact that even when it suffers from headwinds, Southern Company still manages to show fair margins and fair return on equity. If the company will be able to find growth prospects, it will be able to utilize its efficient structure to create more income and more value to its shareholders. Comparison with Wisconsin Energy I will now sum the comparison between these companies. I believe that Wisconsin Energy has superior fundamentals when looking at the past decade and the next five years. Southern Company is valued cheaper, but not cheap enough to justify the lack of growth in the EPS. Wisconsin Energy, doesn’t suffer from huge expenses due to problematic projects such as Kemper in Mississippi. This kind of projects consume a lot of capital, and it will be hard for them to return the money invested. Wisconsin Energy has a lower debt burden. The debt to equity ratio is lower, and it gives Wisconsin Energy more flexibility. Southern company has more debt and a very high payout ratio. This is a combination that can be damaging to the company. It puts the dividend in an unpleasant place. Not only that, Wisconsin Energy is working on lowering its debt after the acquisition of Integrys. Southern Company on the other hand has higher margins and return on equity. This is a positive sign, which is not enough when the company can’t find growth prospects. Yet, to be fair, holding a more profitable company is always a plus. I am writing from my position as dividend growth investor, so it makes perfect sense that I will give Southern Company credit for the higher dividend yield. The dividend yield is much higher at almost 5% compared to the yield of over 3.5% that Wisconsin Energy has. If you look for income it is an important aspect. Conclusion I am certain that Wisconsin Energy can show superior returns for the near future. It has better fundamentals and growth opportunities, and I think that dividend growth investors should prefer it over Southern Company. In my opinion, it will also beat Southern Company in total returns even though the latter has higher dividend yield. I would only pick Southern Company if I were a retiree who is looking for income right here and right now.