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Westar Energy: Why I’m Buying This Midwest Utility

Summary Westar Energy is a solid utility company with an 11-year history of increasing its dividend. Kansas economy grows despite tax problems initiated by its state governor. Westar stock sports a 3.89% yield. I’ve been watching Westar Energy (NYSE: WR ) since 1999. As a journalist, I covered the rise and fall of David Wittig, former Westar Energy CEO, who ran the utility like a hedge fund, making a big bets on various businesses unrelated to electricity generation. Westar Energy was for many years a natural gas and utility business. Because of Wittig’s mismanagement, the company was forced to sell natural gas assets to pay down debt. The debt reduction and subsequent CEOs’ focus on improving Westar’s utility business helped the company’s bonds become investment grade by the rating agencies. The company is way more attractive today as an investment than 16 years ago when I started covering it. I have met every CEO of this company since 1999. Toward the end of his reign Wittig was trying to dismantle the company by selling off assets, it was sad to watch. Investors who bought the stock at $9 per share during the crisis in the early 2000s have done quite well, but at the time, there was a very dark cloud over the company. I believe Wittig should have been running a hedge fund, not a regulated utility. Wittig resigned in November 2002 amid a scandal that involved a local banker in a real estate deal. Wittig’s cloud hung over the company until the two parties settled for $36 million payout to Wittig in 2011. Under CEO Jim Haines, Westar streamlined into a pure-play utility company. Bill Moore continued this mission while embracing wind power and cheap natural gas generation. Current President and CEO Mark Ruelle has picked up momentum by investing in wind generation and transmission projects while upgrading coal fired power plants to meet stringent emission standards. Westar spent over $1 billion in air quality investments in the past five years. The company is winding down expenses in air quality, from upwards of $200 million annually to less than $100 million this year and less than $30 million 2016. A June 2, 2015, presentation says Westar has seen “dramatic improvements in air quality.” Wind Renaissance Meanwhile, Westar Energy has really increased its use of renewable energy, especially wind. Renewable energy is currently 9% of generation mix — more than uranium at 8%. Renewable energy will grow to 16% in 2015. This is huge. And coal is declining. Westar uses cheap natural gas to generate electricity. Natural gas is easier to use than coal. Coal plants take some time to start up and shut down. Natural gas generators are quick to turn on and off. So natural gas assets are timely when the wind isn’t blowing, although the wind blows mightily in western Kansas most of the time. (click to enlarge) A year ago, Prairie Wind Transmission, LLC, a joint venture between Westar Energy and Electric Transmission America, celebrated completion of its 108-mile, 345-kilovolt high-capacity electrical transmission line in south-central Kansas. The double-circuit line will serve as an electric energy super highway between eastern and western Kansas, promoting growth of renewable energy in Kansas, providing greater access to lower-cost electricity and improved reliability in the region. Electric Transmission America is a joint venture between subsidiaries of American Electric Power (NYSE: AEP ) and Berkshire Hathaway Energy (NYSE: BRK.B ) to build and own electric transmission assets. “With our current wind resources and those we’ve already committed to next year, we’ll have enough renewable energy to power half our residential customers,” Ruelle said in a recent call with investors. Ruelle said Gov. Sam Brownback has favored renewables. “It’s just pragmatic Kansas politics,” Ruelle said . “He has been a big sponsor of renewables and supported renewables for what it means for rural Kansas. But as you also know there are folks that don’t like the concept of subsidize the energy period and Kansas has made a lot of progress in renewables and everybody has sort of been doing it…We have been doing it because that makes sense economically. And basically Kansas got to a place where we didn’t think a mandate was probably needed to step it up. We’re doing it not because of the mandate, we’re doing it because it’s relatively inexpensive and it’s a good way to navigate the environmental rates.” Westar Energy is the largest electric energy provider in Kansas, providing generation, transmission and distribution to approximately 687,000 customers in east and east-central Kansas. The company is headquartered in Topeka, and employs about 2,400 people in Kansas. Its energy centers in 11 Kansas communities generate more than 7,000 megawatts of electricity, Westar operates and coordinates 34,000 miles of transmission and distribution lines. The Economy The Kansas economy has grown slowly and steadily since the Great Recession of 2008-09, but lags the robust growth of Nebraska or Colorado. Kansas Gov. Sam Brownback is business friendly, but his tax policy has drained state reserves and forced cuts to education and welfare. The political situation here is backward to say the least. Growth occurs in places like Wichita because it is more entrepreneurial than Topeka, it’s not surprising that Pizza Hut started in Wichita. You will find more entrepreneurs in western Kansas than in the statehouse of Topeka. Kansas’ Gross State Product has grown from $121 billion in 2009 to $144 billion in 2013. In a recent conference call, Ruelle said, industrial sales were mixed to down. “The biggest negatives are from our largest chemical manufacturer and pipelines reflecting the impact of lower oil prices,” Ruelle said. “On the positive side, the refineries were operating at capacity and commercial aerospace remains strong. Other good news is that the large candy maker (Mars) who just came to our service territory a couple of years ago has already announced a big expansion and that will add a few more megawatt to our sales.” Rate case Westar Energy asked regulators for a $152 million rate increase but the Kansas Corporation Commission staff recommended $55 million based on a 9.25% Return on Equity (ROE). “If adopted that would be among the lowest authorized ROEs in the nation,” Ruelle said on the investor conference call. I believe the KCC’s proposed 9.25% ROE is lower than the historically 10% to 11% ROE built into previous rate cases. The KCC’s decision on the rate case is expected by Oct. 28 with implementation of new rates in November. I predict a negotiated settlement somewhere around $75 million. That would add $0.53 cents per share in revenue or about $0.06 cents per share in profit. EPS for the trailing 12 months was $2.25 per share, while the company is predicting 2015 earnings guidance at $2.18 to $2.33 per share. An additional $0.06 cents from the rate case would increase EPS by 2.6%. With large air quality projects finishing in 2015, the company’s need to raise capital has diminished. The company has a decent balance sheet, plenty of liquidity and no need for new equity. As a result, I expect the company to continue its trend of increasing its dividend. Growth and income investors will like this: The company has increased its dividend every year for 11 years. Payout ratio is reasonable at Westar Energy. Company pays out 60% to 75% of earnings in dividends. The current $0.36 cent per share quarterly dividend is a yield of 3.89%. I like the stock at $36.00. I believe the stock is fully valued at $40 per share. WR was trading at $39 per share in mid August before the recent stock market correction. Risks It is likely the Federal Reserve will start raising interest rates. This may or may not happen in 2015, but I do expect rates to go up by fall 2016. The cost of debt will go up for all utilities, including Westar Energy. However, I believe we will see relatively low interest rates for many years, perhaps the next decade. Economic growth is sluggish in Kansas. Gov. Sam Brownback eliminated income taxes for most small businesses, with the hope the owners would re-invest the tax savings into job creation. But business owners, farmers and ranchers did not need additional employees, so they never went on a hiring spree as Brownback had hoped. With a reduction in state revenue, local school boards will likely raise property taxes to fund the education gap. Weather has been mild all year, reducing the need for a boost in generation that is typical in summer months. Conclusion Westar Energy is a solid company with good management. A year ago I had purchased Westar stock at $36 per share and sold it at $40 per share. I recently bought shares at $37.07, and may add shares at lower prices. The stock market is going through substantial volatility. I can sleep at night owning this stock. People need electricity. Westar rates are among the most affordable in the country. I believe a rate increase will happen this fall and the company will be able to raise its dividend in 2016. Disclosure: I am/we are long BRK.B, WR. (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.

Are You Selling The Drama Or Buying The Rally?

The critical concern at this juncture is to address whether or not new information genuinely makes risk taking more desirable. Have prospects for the global economy truly improved? If history teaches us that benchmarks tend to retrace half of their losses before retesting their lows – if you feel like you’ve been here before and you don’t choose to be scarred like that again – perhaps you might anticipate better buying opportunities in the weeks ahead. Mini-crash for equities ignites panic selling? Check. The commodity super-slump, ever-widening credit spreads, corporate sales recession and rapid deterioration in market internals throughout June and July assured a reassessment of risk. The brutality and swiftness of that risk reassessment was less destructive for those who respected the dozens of warning signs and acted proactively. Extremely oversold conditions and short covering spark panic buying? Check. As I explained on Tuesday after six days of relentless price depreciation, the S&P 500 had only closed on the lowest end of its 3-standard-deviation range (0.13% probability) on two other occasions – at the tail end of the eurozone sell-off (10/3/2011) and on Tuesday, 8/25/2015. That’s why I wrote in Tuesday’s article, ” Yes, you’re going to see higher prices in the immediate term. Relief rallies happen . ” On the other hand, corrections in other key historical periods (e.g., 1987, 1998, 2010, 2011, etc.) suggest that relief rallies are likely to be short-lived. Typically, stock prices bounce significantly off potential lows, then retest those lows a few weeks later. The S&P 500 SPDR Trust ETF (NYSEARCA: SPY ) plunged 16% in late July-early August of 2011. The exchange-traded index tracker went on to recover one-half (nearly 8%) in late August and September, but ultimately broke to new lows in early October. Similarly, the current correction for SPY came close to 12%. Should anyone be surprised in the vehicle’s ability to reclaim one-half (approximately 6%) of the erosion in price? If history teaches us that benchmarks tend to retrace half of their losses before retesting their lows – if you feel like you’ve been here before and you don’t choose to be scarred like that again – perhaps you might anticipate better buying opportunities in the weeks ahead . The critical concern at this juncture, however, is to address whether or not new information genuinely makes risk taking more desirable. For instance, have prospects for the global economy truly improved? Are corporations actually going to post top-line revenue increases in the 3rd quarter or blockbuster profitability in the 3rd quarter? Will the Federal Reserve’s timeline for tighter borrowing costs be compatible with real prospects for the U.S. economy? If the answers to these questions are “affirmative,” then stocks may be off to the races. Let’s start with the macro-economic backdrop. Is it possible that the seasonally adjusted, revised-and-re-revised GDP of 3.7% for the U.S. in Q2 is a game changer? Probably not. For one thing, the economic growth for the year is at 2.2% – the same low annualized rate that it has been throughout the six-year recovery. Second, the most respected forecasting arm of the Federal Reserve, the Atlanta Fed, anticipates 1.4% 3rd quarter GDP, which means decelerating activity. Last, but hardly least, the global economy is reeling, from debt-slammed Europe to commodity dependent Latin America to recession-wracked China. It follows that prospects for the global economy do not look substantially better, other than the hope and faith that investors may place in China’s multi-faceted stimulus efforts. Perhaps there is new data to suggest that corporations are growing their bottom line earnings per share that would justify a sustainable bullish stock uptrend. This does not look to be the case. According to S&P data compiled by the web log, Political Calculations, trailing 12-month earnings per share for the S&P 500 have declined from S&P analyst projections throughout 2015 from the projections analyst made three months ago (May 20, 2015), six months prior (February 15, 2015) and nine months earlier (November 13, 2014). Top-line revenue? The revenue recession began at the start of 2015 as the Dow Industrials posted sales declines in Q1 (-0.8%) and Q2 (-3.5%); analyst projections for sales declines are coming in at -4.0% for Q3. So new information on the global economic expansion is not particularly compelling. Meanwhile, companies do not appear to be enhancing their top or bottom lines, which does not help price-to-sales (P/S) or price-to-earnings (P/E) valuations. Why, then, would stock investors become enchanted by anything that has taken place in the last few days? Granted, President of the New York Fed, Bill Dudley, helped send stocks rocketing on Wednesday (8/26) with commentary that hiking the Fed’s overnight lending rate in September is looking “less compelling.” Anything that pushes off the possibility of higher debt servicing costs or higher financing costs excites stock bulls. Keep in mind, of course, nobody at the Fed has suggested that they would not raise interest rates here in 2015. It follows that the hope for a continuation of Fed accommodation – hope for a rate hike delay, a slower pace for rate hikes (e.g., every other meeting), and/or smaller increments (one-eighth of a point) – remains the best bet for stock bullishness. We are still proceeding with caution. Most of our clients have 50% exposure to domestic equity ETFs such as the iShares S&P 100 ETF (NYSEARCA: OEF ), the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ), the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ), the Vanguard Mid-Cap Value ETF (NYSEARCA: VOE ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ). In some instances, we have bought the dips on accidental high yielding dividend aristocrats like Wal-Mart (NYSE: WMT ). Investment grade bonds make up 25% of most portfolios with funds like the iShares 3-7 Year Treasury Bond ETF (NYSEARCA: IEI ) and the Vanguard Total Bond Market ETF (NYSEARCA: BND ). Most importantly, in May and June, when the S&P 500 regularly sat near the 2100 level, we raised our money market cash account levels . Those cash levels are still at 25%. The purpose? Cash reduces portfolio volatility during periods of market stress, limits the downside loss during sell-offs and provides opportunity to buy quality assets at lower prices. Even if I am wrong about the S&P 500 retesting its lows, we are unlikely to miss the bull train as we await a definitive confirmation of improving market internals . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Do Not Blame China For Your Missed Opportunity To Reduce Risk

I did not predict the epic fall from grace for the S&P 500 SPDR Trust (SPY). There’s a whole lot more to the extreme selling pressure than drama on the Chinese mainland. The reality is that the financial markets had been telegraphing distress in dozens of meaningful ways for months. I’m not likely to add significant risk anytime soon, short of the Fed giving us another Bullard-like moment where rate hikes are off the table and QE is back on the table. In large part, I will take cues from key credit spreads and price ratios like the iShares 7-10 Year Treasury (IEF): iShares iBoxx High Yield Bond (HYG). Some are crediting me with calling the 6-day mini-crash. On the contrary. When I wrote “ 15 Warning Signs Of A Market Top ” on August 18, the intent was to discuss micro-economic (corporate), macro-economic, fundamental and technical reasons for reducing one’s overall allocation to riskier assets. I did not predict the epic fall from grace for the S&P 500 SPDR Trust (NYSEARCA: SPY ). Based on a Relative Strength Index (RSI) level below 17 – based on the fact that we are approaching lows not seen since October’s “ Bullard Bounce ,” one should anticipate a jump higher. Equally compelling? Since the bull market’s inception (3/9/2009), the S&P 500 has only closed in its 3-standard-deviation range (0.13% chance of occurrence) twice. It happened at the tail end of the eurozone sell-off on 10/3/2011; it happened again today, on 8/25/2015. Yes, you’re going to see higher prices in the immediate term. Relief rallies happen. On the flip side, it’d be foolish to think that a jump off of the floor will be enough to restore the bull market uptrend. Institutions, private clients and hedge funds will need to shift from net sellers to net buyers; they were net sellers in July and August . The pattern of decreasing revenues and decreasing dividends at corporations will need to show marked improvement. Credit spreads need to stop widening and perhaps begin to narrow, demonstrating greater confidence in borrower creditworthiness. And speaking of borrowing, the Federal Reserve will need to come up with a way to inspire as it raises overnight lending rates. A plan for a one-n-done hike across a six-month span? Perhaps an offer to move at a snail’s pace of just one eighth of a point every other meeting? The media may choose to pin all of the blame on China’s stock market collapse. Indeed, interest rate cuts, trading halts, short-selling bans, currency devaluation, looser lending rules and share-buyer incentives have done little to stop the exodus. Keep in mind, though, Chinese equities via db-X Trackers Harvest CSI-300 A Shares (NYSEARCA: ASHR ) crashed in June and July. The S&P 500 was within 1%-2% of its all-time high less than a week-and-a half ago. It follows that there’s a whole lot more to the extreme selling pressure than drama on the Chinese mainland. The reality is that the financial markets had been telegraphing distress in dozens of meaningful ways for months. The Dow Transportations Average had been sickly since the first quarter earnings season, suggesting that manufacturers were not delivering as many goods for worthwhile profits. By early June, broad-based energy corporations in the Energy Select Sector SPDR ETF (NYSEARCA: XLE ) had climbed off of March lows, but they were still mired in a sector-specific bear that began in late 2014. Equally disturbing, at one point in June, the price-to-book (P/B), price-to-sales (P/S) and price-to-earnings ratios (P/E) for the “median” stock on U.S. exchanges had never been higher. Not even during the delusional dot-com days of 2000. As investors were entering July, troublesome deterioration began occurring in market breadth. The Bullish Percent Index (NYSE: BPI ) for the S&P 500 still showed a bullish reading above 50% (59%), yet less and less S&P 500 components had been forging uptrends. Prominent sectors like the Industrial Select Sector SPDR ETF (NYSEARCA: XLI ) began pushing 8% corrective levels on weak wages and weak manufacturing data. Later in July, foreign developed stocks were dropping precipitously and diverging from the U.S. market, highlighting the fading enthusiasm for euro-zone quantitative easing (QE). And high yield bond distress was a clear indication of credit risk aversion . The point here is, we hadn’t even gotten to August, and the signs of a probable sell-off in U.S. equities had been everywhere. You want to blame the second leg down of the stock market bear in China for everything? Why ignore the first leg? Why dismiss free-falling commodities in the summertime, from oil to copper to base metals? Why act as though the consecutive quarters of decreasing sales and lackluster profitability at U.S. corporations hasn’t mattered? Or the anxiety about Congress and the White House with respect to upcoming budget negotiations? Or the most obvious issue of all – angst over the Fed’s explicit goal of hiking rates as early as September. It follows that I have been discussing a tactical asset allocation shift for several months in my columns. I offered simple solutions, such as a moderate growth investor with 65% growth (e.g., large, small, foreign, etc.)/35% income (e.g., investment grade, high yield, intermediate, long, etc.) shifting to 50% growth (primarily large cap)/25% income (primarily investment grade), 25% cash/cash equivalents. A number of anonymous commenters at sites where financial portals regularly republish my articles demonstrated a remarkable penchant for viciousness. They attacked out-of-context word choices. They slammed the evils of rebalancing through tactical asset allocation as market timing idiocy. Some merely raged against my so-called negativity. Ironically, few could debate the array of well-researched and well-presented data – fundamental, technical, micro-economic (corporate) and macro-economic information that served as the basis for my recommendation to “sell a few things high” and hold some cash to limit downside loss and prepare for a future “buy lower” opportunity. And therein lies a problem for the complacent among us. The definition of opportunity is relegated to the “buy side.” Why should that be? When there are 30 some-odd reasons for reducing risk compared with a handful of reasons to stand like a possum in the headlights (I gave 15 in the Market Top feature from one week ago ), shouldn’t we embrace opportunities to lock in profits and/or protect our principal? I appreciate the kudos from those who have written – personally or on message boards – to thank me for “getting them out” in the nick of time. But I don’t have a crystal ball. And I did not suggest leaving risk assets altogether. I simply made the case for why the time for target risk allocations or greater-than-normal stock exposure had exited months ago. I’m not likely to add significant risk anytime soon, short of the Fed giving us another Bullard-like moment where rate hikes are off the table and QE is back on the table. I may even sell a bit more into the oversold conditions that are likely to bring about relief rallies. In large part, I will take cues from key credit spreads and price ratios like the iShares 7-10 Year Treasury (NYSEARCA: IEF ): iShares iBoxx High Yield Bond (NYSEARCA: HYG ). If the IEF:HYG price ratio is declining, a preference for risk-taking would be increasingly evident. That’s clearly not the case today. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at th e ETF Expert web site. ETF Expert content is created independently of any advertising relationships.