Summary The company has increased dividends every year for more than 40 years. This is one of the few utility stocks to show significant capital gains in its history besides times when interest rates decrease. Even with the acquisition, the company’s financial outlook remains reasonable. The company continues to invest for future growth. The company has several ways to participate in the recovery of the oil and gas industry when the recovery arrives. The company is well diversified among several states which should increase the stability of the dividend and the return to shareholders. Black Hills Corporation (NYSE: BKH ) has been around a long time and boasts one of the best dividend records out there. The company has not only paid a dividend it also increases that dividend. However, the capital gains picture has not been kind to the company for the last ten years, which is roughly from the time of 2006 and includes the last very significant recession. The price of the stock has been relatively stagnant as the chart below shows. Nonetheless, the company has some good fundamentals and is probably worth a good look by the serious investor looking for a relatively safe and consistent return. The dividend yield is becoming significant, even generous for a company with a large utility component, but also an unregulated component that will provide future growth. The combination of future earnings growth and dividend yield is worth looking at here to see if it suits the risk averse investor. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 So the question remains as to whether or not the company has lost its touch. Currently its most visible customers, the oil and gas companies are laying off employees and decreasing activity. Some are going bankrupt. The company itself has an oil and gas division that is showing enough losses to eliminate reported profits. Normally an investor would run the other way. But this company has such a consistent history prior to now that it would be wise to see if investing contrarian style could be a winning strategy. Plus it announced an acquisition, the latest of many prior successful acquisitions. At one point, in its history the company not only had attractive dividends but also showed significant appreciation. The chart above shows a return of 9.2% for twenty years which is very attractive for such a low risk stock that pays a significant and secure dividend. The last ten years, however, the rate of return is only 3.7% which may not even cover the dividend return for that period of time depending upon when the stock was purchased. Now admittedly, the economy was in far better shape in the earlier part of the twenty year period than it has been in the last ten years, and there are plenty of companies with far worse returns because the economy took a very significant dive around 2008. Still it is worth looking into to see what the company is doing now. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 From a dividend perspective , it is still growing and that is a very large indication that the company is on the right track and has not lost its touch. The current dividend yield is nearing a four percent yield and based upon past history, an investor can expect about a 1.5% increase in that dividend each year in the future. There is an occasional larger jump. A look at the earnings picture may well modify this stance. It’s even more significant that the company retains nearly 60% of its adjusted earnings for reinvestment in the business and potential diversification. Many utilities pay out far more earnings, and hence the dividend growth rate is lower or there is no growth rate. Some of this retention will be explained below where it is shown that the electrical and gas use is growing, so investment is needed to keep up with the growth in demand. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 When the earnings picture is reviewed, it’s clear that dividends may increase at a faster rate in the future. Earnings have grown at a 15% compounded rate for the last five years, but dividends have only grown at 2%. That earnings growth rate is far faster than the typical utility, although some of that growth could be a recovery from the 2008 downturn. For the last few years this company has been located in some of the hottest oil and gas plays in the country. This utility services Montana (which has part of the Bakken play), Colorado, and Wyoming. All of these areas have major shale oil plays, and with the production growing rapidly, there is a need for employees who with their employers use electricity and gas (until the current downturn). The company has also made acquisitions at an average of one a year or so, and obviously those acquisitions have helped the profit picture. The company has also integrated itself more fully, mining coal to provide coal for its power plants, and drilling for gas to provide gas for its power plants and customers. It also has a wholesale electric company. So this company has several ways to grow. It can grow by integrating new acquisitions and implementing new efficiency measures, by the growth of the non-regulated business, and by growing its regulated business as allowed by law (although this is by far the slowest of the three possibilities). The first two avenues of growth are not usually available to utility investors. The company emphasizes the non-gap results because the oil and gas division is currently negating all the corporate earnings because of the ceiling calculation writedowns. Those writedowns confirm that money spent a few years ago was not profitably spent, and therefore is now officially a loss. They are known as a sunk cost. In the current low price oil and gas environment, those expenditures will not be recovered. But those charges do not affect current cash flow, future earnings growth, or really change the outlook of the company. When removing those non-cash charges, the company is still showing impressive growth in the other divisions. That growth will show on the income statement as soon as the ceiling cost adjustment ceases to be a factor in reported earnings. More importantly, the oil and gas business has been profitable for the company in the past, and it has reported gains (for example) on the sale of some of the properties in that division so there is reason to hope for profitability of this division in the future. The division was small enough to not cripple the company when something like these writedowns occurred, but big enough to provide significant gains to shareholders in the past and hopefully the future. The company has a solution for the future of those writedowns in the form of cost of service gas support. The interesting thing is that the company has to be better than average (in selling gas to its utilities from the exploration company) for it to be allowed to earn an extra 1% on its ROE, and it has a customer base for its gas that is long term and possibly less demanding than many other companies that are not regulated. Right now, this is just a proposal, and has not yet made it through all the regulatory hurdles (nor is there any way near enough significant operating history on this proposal), but if approved (and if it works as management thinks it will), would be a way to avoid the cost ceiling writedowns that has concerned the company and the whole exploration industry. The company would avoid future charges by locking in long term supply contracts to retail customers at a fixed price and avoid the spot market swings. Furthermore, that solution is unique to this company because it has a an oil and gas subsidiary (that is mostly gas) as well as utilities to sell its production to. As a conglomerate, more so than a utility, this company continually finds ways to make the sum of its parts more than each part separately, and this is just one example of what the company has accomplished. To prepare for the implementation of the proposal, the company has decreased its capital spending to accommodate the current low commodity prices. It has also decreased the well costs and increased well productivity considerably. So it is working hard to make that subsidiary above average and meet the regulation requirements needed for the cost of service gas support program. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 Despite the cyclical nature of both the oil and gas business and the coal mining business this company is succeeding in steadily growing its non-regulated business over time as shown by the growth in the non-regulated operating earnings. There are going to be hiccups, such as the oil and gas ceiling cost writedowns, and they definitely hurt. But the company has found a formula to consistently increase cash flow, operating earnings, and maintain that dividend (even grow it) through the disappointments. For the risk averse investor that wants consistency, this accomplishment is worth noting. The company has also noted that it has acquired 19 utilities in about the same number of years and integrated them. That is a fair amount of practice leading up to a larger acquisition. A strategy of making periodic small acquisitions (and an occasional large one) usually pays off better for shareholders than making one giant acquisition (with no previous acquisition experience), and here is a case in point. The current proposal for a large acquisition, the SourceGas acquisition has a far better than average chance to add to earnings within the first year. There is enough history of acquisitions to add credibility to that statement even though this acquisition is larger than the typical ones the company has made in the past. Also an investor would expect the combined company to maintain its investment grade rating. Therefore the investor should expect the growth in earnings, cash flow, and operating earnings to continue. That growth might even temporarily accelerate from the acquisition. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 The significance of this particular slide is that the company is investing in its future to grow. Notice the continual investment that exceeds the depreciation charges. Plus the company noted that its customer base does increase around one percent or so a year. Because many of its service areas (all of them in fact) are located outside of major cities, the plant size tends to be smaller, and with the company’s diversification, it is not dependent on really any one area (more than the others) for much of its revenue. In short the company has a lot of small power plants, rather than a few big ones (like some of the big city setups). So when the government decided it was time to reduce emissions, this company is having an easier time replacing its coal plants with natural gas fired plants (and reducing emissions of the remaining plants until the proper replacement time). Its new power plants, because of their size often are completed within budget and on time. With the diversification of the company, replacing one power plant, is not the strain it would be on a company that is not so diversified and dependent on a few large plants. The government may want to speed up the replacement process and that would put a strain on the company finances, although the regulatory process would allow for cost reimbursement. Still the company has an investment grade rating, and that rating is unlikely to change because of the current emphasis on emission reduction. Although the current ratings outlook is reflecting the current uncertainty of the merger. For the time being, the coal fired plants and the issues surrounding them are not a drag on discretionary cash flow to the point where future dividend growth would slow. Even in a worst case scenario, the company is well diversified that an emphasis to change from coal to gas or otherwise reduce emissions would be mitigated by the company’s diversification. The company has many small rate increases because of its extensive diversification. One unfavorable rate increase ruling is unlikely to derail the company’s growth plan. Plus should one state become utility business hostile, the company is in a position to spin off that division and emphasize the more growth or rate of return friendly areas. Once the merger details are known, the negative outlook by the ratings agencies should be quickly revised. Otherwise, the company’s finances currently appear to be able to handle whatever capital investments and debt financing are needed for the future as the debt markets are definitely open for this company. The company also appears to be receiving a return on its investment and diversification in the form of higher adjusted earnings, operating earnings, cash flow, and the ability to increase dividends. Admittedly the oil and gas division is an exception, but after a year or so that exception will be gone. The company has a history of profitability in its non-regulated subsidiaries (it has ten years of experience in the oil and gas business and experience in the coal mining business also), it has even sold pieces of these subsidiaries for gains and spun at least one of the subsidiaries off to shareholders in the past. In short there is a history of both experience and success with non-regulated subsidiaries that should be expected to continue and add to profitability in the future. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 The company numbers among its customers some very large growing companies. Interestingly, it lists a Microsoft (NASDAQ: MSFT ) location as a major customer. That kind of diversification is not really well advertised but does exist in its service area (see slide below). It is known for having a lot of oil and gas companies as its customers. That customer diversification in the service areas is the reason that the company is showing growth through the oil and gas downturn. Should profitable times return to the oil patch, this company can be expected to participate in the growth of those firms by selling them more electricity and all the related businesses. Plus it has non-regulated subsidiaries that will participate in the recovery. In the meantime, showing any growth at all in this downturn is a major accomplishment. The company does note that its service area includes some of the lowest unemployment areas in the country and that certainly helps. As a result, the expected decrease in earnings from the more visible oil and gas industry in the company’s operating areas has not materialized. The advantages of the diversification of the company are being demonstrated yet again. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 As discussed above and referenced from the company presentations , the merger still has a few hurdles to clear, but the experience of the company making acquisitions is shown by this slide. There are a large number of service overlaps and adjacent areas that open themselves up to economies of scale after the acquisition, and could provide several years of profitable utility growth to the combined company. Notice that no one service area is so dominant that the company relies solely on that area for its profits. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 In reviewing the company’s goals, I take some comfort in all the oversight through regulation of the company’s financial health. It must maintain in most cases (through each subsidiary) a minimum amount of equity of 40% vs. long term debt. Overall the company maintains an equity level (vs. long term debt) usually in the 48% level and has room for things such as the writedown of oil and gas properties due to the ceiling calculation. That writedown will not affect the equity at the utility subsidiary level which is required by each state. The utility subsidiaries can still pay dividends to the parent company so that the parent company can pay dividends to the shareholders. The writedown does affect the overall company results, and the oil and gas subsidiary. However, with the company reporting operating income of roughly $275 million this year, the loss caused by the oil and gas ceiling calculation of more than $100 million will be easily replaced. The writedowns will not cripple the parent company. With the healthy state of the other divisions, that total company equity to long term debt ratio will recover once the writedowns stop. To its credit management has come up with a proposal to avoid those writedowns in the future, a sign of good management. Conclusion The goals themselves really are more of the same of what has made the company successful in the past. Maybe, the stock got a little ahead of itself (or maybe the recession really did slow the growth rate for a few years) and that is the reason for the sub-par returns for about five years. However, the latest five year period returns are superior and based upon the capital budgets, the proposed acquisition, and operating earnings, as well as customer growth, the key basics look to be in place for a rewarding future. The company looks to be back on track, especially when the investor reviews the returns of the latest five years in comparison to the returns of the latest ten year period. The oil and gas industry downturn has not slowed customer growth, usage growth, cash flow, and earnings growth. Those current ceiling cost charges reflect investments made in previous years that are not currently profitable. They don’t affect current operations. Therefore this company should continue to grow earnings in the seven to ten percent range for the foreseeable future. When this is combined with the nearly four percent dividend, the total return from an investment at the current price of the stock ( approximately $46 lately)looks to be a very attractive eleven to fourteen percent for the future. The price-earnings ratio appears to be about twelve without the oil and gas writedowns. That is a very reasonable price to pay for these returns. (click to enlarge) Source: Black Hills Corporation Analyst Day Presentation October 8 Raising guidance is usually reserved for well run companies , and I believe that is the case here. The company has also provided some fairly detailed assumptions that look fairly reasonable. The major acquisition is not expected to close until next year, and the company has even set a public goal to complete the acquisition and have it add to earnings the first year. This is a reflection of the certainty of management in the acquisition as well as the practice of having made so many acquisitions in the past. Plus any efficiencies earned from the upcoming acquisition will provide the shareholder with significant upside potential. Clearly this company is looking forward to more profitable growth and shareholders can look to profitable returns that will probably be superior to what was achieved in the last ten years when the economy took a nose dive. There are risks to any acquisition, and with a large acquisition there are large risks. However, those risks are mitigated by the number of successful acquisitions this company has made in the past. While the debt rating agencies are a little skittish and will remain so until all the details of the acquisition are known, the company has a history of maintaining an investment grade rating, and can be expected to do so in the foreseeable future. Disclaimer: I am not an investment advisor and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.