Tag Archives: management

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.

El Paso Electric: The Best Of Both Worlds

El Paso Electric Company has grown its renewable energy portfolio to a well-crafted portfolio aligned with EPA expectations. A high dividend yield with the potential for even higher yields later on give investors a fat dividend check to look forward to. Investors should consider El Paso Electric Company for a two-pronged investment in capital appreciation and capital preservation. After the recent poor performances in the overall stock market, investors are pining for higher returns. But before they run away from the stock market and look for higher returns, they should consider investing in small cap companies in the stock market. As a whole, small cap companies have generated higher returns than mid cap companies or large cap companies, and they have also outmatched various passive indices in return on investment generation as well. This is simply due to the fact that small cap companies have more room for growth than mid or large cap companies, and therefore this extra growth can generate higher returns for investors. Of course, this growth comes with its risks as well. Small cap companies are more likely to go belly up, which is why investors need some method of mitigating the risk involved with investing in small cap companies. One way investors can reduce the risk of investing in small cap companies is through the investing in small cap companies in stable industries. These industries can include industries such as utilities or industrials, given the inelastic demand and high diversification of these industries. The stability of these industries combine with the growth of small cap companies to yield a unique blend of risk and reward. Both capital preservation and capital appreciation are given by this mix, not to mention the steady quarterly paycheck that comes from dividend payouts. One such firms that offers this unique blend is the El Paso Electric Company (NYSE: EE ), a small cap utilities firm engaged in the generation, transmission, and distribution of electricity to a variety of customers in Texas and New Mexico. The Company owns several generation facilities, and it primarily distributes electricity to retail customers. The Company’s ownership interests in these generation facilities provide the Company with a unique blend of investments in various submarkets within the utilities industry, such as nuclear power, natural gas, and other areas of energy. Thus, the Company is well-diversified, providing investors with additional stability. Investors certainly should be pleased with how the Company has done over the years. Capital invested at the onset of calendar year 2011 would have generated a return on investment of about 70% over the course of five years. Although the overall rate of growth is a little slow, the Company’s stock has done nothing but grow steadily over this time period, essentially exchanging rapid, volatile growth for stable growth. Recently, the Company’s shares have begun to trade somewhat sideways as a result of macro instability in the emerging markets, which has affected not just the Company but the overall stock market as well; thus, this stagnation is not Company-specific. From a technical perspective, the 50-day moving average has danced around the 200-day moving average, but both indicators have moved in the positive direction for the past five years in a general manner. Most recently, the 50-day moving average has risen above the 200-day moving average, which could indicate near-term upside as the spread between these two indicators continues to rise. (click to enlarge) Source: Stockcharts.com But it’s not just the technicals that are painting a pretty picture. The Company’s fundamentals are fairly outstanding as well. With a dividend yield of about 3.2%, investors are having the opportunity of substantial capital appreciation (because the Company is a small cap company) as well as the opportunity for a stable, fat dividend check. In fact, the Company plans on growing this dividend yield to about 4 – 6% in the long-term, so investors could see their dividend checks swell even more. Besides this enormous dividend yield (given the Company’s size) and the opportunity for further dividend yield expansion, the Company also has fundamentals that indicate future long-term growth for the Company. In particular, the Company’s energy portfolio will consist of nuclear power, natural gas, and other renewable energy sources. As a result, the Company’s energy portfolio aligns with the interests of the EPA Clean Power Plan (CPP), which could benefit the Company in the long-term if it decides to either keep or grow this particular part of its energy portfolio. Furthermore, while top-line growth and margins have been relatively stagnant, what’s important to keep in mind is the Company’s retained earnings balance, which has steadily risen over the past several fiscal years. The rising retained earnings balance will help buffer dividend payouts, and it will help management reach its goal of a 4 – 6% dividend yield. Overall, we have a small cap utilities company with an extremely high dividend yield and an energy portfolio in-line with what the EPA wants. Investors should consider El Paso Electric Company for a two-pronged investment in capital appreciation and capital preservation.

VEU: This Passive International ETF Sets A High Bar

Summary The ETF has an excellent expense ratio. Investors need to remember the importance of international diversification even as domestic equity as thoroughly outperformed during the latest bull market. The ETF is highly diversified through over 2500 individual holdings. The sector allocations are very similar to the benchmark and to the category average. Peers with similar allocations and higher expenses are facing a tough battle. The Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) is a very solid international ETF. During the recession several years ago it took a pretty harsh beating but the value that was lost has been recovered since. International funds generally have been thoroughly smashed by domestic equity since the recession, but investors would be wise to remember the importance of some international allocations. Expenses The expense ratio is a .14%. Vanguard regularly sets the bar for creating low fee investment vehicles for investors to gain solid diversification with low costs. Holdings I grabbed the following chart to demonstrate the weight of the top 10 holdings: While these companies are international, some do have some fairly material direct exposure to the United States. Toyota Motor Corp (NYSE: TM ) certainly has a substantial presence in the United States and despite the problems the company has seen they have plenty of room to grow. As an analyst, it is rare to turn off the finance side of my brain. When I was visiting the local dealership for Toyota, there were a few things that stood out. To be clear, I believe that Toyota makes an excellent product. I believe their manufacturing practices are excellent. However, I believe their customer service strategy has been a severe handicap. This is important to the future performance of Toyota Motors because their ability to bring customers in on the service side of the business is dependent upon having satisfied customers. I fall into their target demographics. I’m a huge fan of their product line and have no intent to own any other brand of car for at least the next couple of decades. I put together a much more complete assessment of the weaknesses and potential fixes for their customer service flaws. Sectors (click to enlarge) You may notice an interesting thing in the sector allocations. The bench mark weightings, VEU’s weightings, and the category average weightings are generally fairly tight for any sector. There are quite a few funds where Vanguard is sticking to an index in a way that peers are not and the result is a material difference in the allocation weights. The reason this is material is because VEU has such a low expense ratio relative to other international ETFs. If Vanguard is going toe to toe with another fund manager that offers very similar sector exposures and a much higher expense ratio, then VEU has a huge advantage. For the other ETF to win, the opposing fund manager will have to manage the portfolio to have significantly better performance within the same sectors by regularly delivering superior analysis of the individual companies in the sectors. Some investors believe that will regularly happen, I believe it is more likely to reflect sample sizes than incredible skill levels. When the allocations are going to be very similar, I believe the low cost leader has huge advantage and will win over the long term most of the time. Region This is a fairly steady allocation with emerging markets being weighted at 17.7% of the portfolio. Europe gets a fairly huge weighting, so I wouldn’t combine this ETF with other international ETFs that are going heavy on Europe. Instead, I would simply cross off the other ETF and look for one that created a better match for VEU. Who wants to give up a low expense ratio on a fund with over 2500 individual holdings? If you want diversification, this is it. It makes more sense to drop other competing allocations. If investors feel more aggressive, they may want to consider adding on to the emerging markets exposure here. For the investors that want to make their portfolio more conservative, they might stick to using VEU for their entire international equity position. On the other hand, if they still find that using this for 10% to 15% of the portfolio is too dangerous, they may want to simply reduce the allocation in favor of short duration high quality bonds. Conclusion This is a great international ETF. It offers investors thoroughly diversified exposure and extremely low expense ratios. Even for investors that choose not to use VEU, it is very hard to make an argument against including it in any discussion for “best of breed” status among international ETFs.