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NextEra Energy’s Valuation Still Too Rich, Catalysts For Long-Term Growth Strong

Summary Our pricing has moved up, but we are still looking at a $96 price tag. NextEra’s strong quarter in the latest earnings show great strength in renewable energy but comps were weak. Hawaiian Electric deal is moving along well, but it will still take another 9-12 months to finalize. Today, we are going to take a refreshed look at NextEra Energy (NYSE: NEE ). We first looked at the company in late February. At that time, we thought the company was fairly priced with potentially some room for a pullback. The reason was that we believed that the market was slightly overvaluing the utility space, and a correction was due. Since that report, the stock has dropped over 5% to the upper-90s. We noted we would be interested at the 90-level. Our main thesis was that, while the company’s health and catalysts were strong, valuations were pricing in a best-case scenario of 6% revenue growth and 22% operating margins consistently moving forward. We worried that was too aggressive perhaps, and even if not, an even better scenario would be needed to see upside. Today, we want to revisit our catalysts in the wake of the last set of earnings as well as other developments that have occurred. Additionally, we will take another look at our pricing model to update that given this analysis. 2015 Catalysts Revisited Economic Moat Strength What we saw as really the overall #1 strength of NEE was its dominant economic moat that it was able to have due its non-competitive arrangements with municipalities. What that means is that the company negotiates a “fair price” for a certain area if the municipality agrees to limit competition. Most areas of the country have similar agreements, and it helps to establish infrastructure and investment from utilities, while guaranteeing power, service, and price to end customers. As we noted before, NEE is very attractive because about 80% of its business is in the regulated arena, where profitability is strongest. This image from Market Realist tells the tale: (click to enlarge) The company maintains one of the highest margins in the industry with this strong mix, and there is little threat to a major push down. As long as the company can maintain this strong mix, it will be attractive for income, long-term investors. The real benefit or issue that could move the needle, though, was the company’s work in Hawaii… Hawaii – Another Regulated Market to Add Shareholder Value In 2014, NEE bought Hawaiian Electric (NYSE: HE ) for north of $4B. The move was a chance to come into a new market that was in need of cost savings and be able to combine a regulated market with the company’s practice of making efficient utility deliveries. Additionally, the company will bring its penchant for renewable energy to help build a better “mousetrap” in the state. The company had plans to revolutionize the space with solar energy. The state is one of the best for solar energy. So, how have things been moving since the last time we looked at the company. There have been quite a few developments. Right now, the main aspect of the deal is just to get it done and approved. In April, HE’s CEO came out saying he was confident that the deal would be completed within a year, and the Hawaiian House of Representatives put a resolution in place to complete the deal by June 2016. Given the market is regulated, it is a major decision for Hawaii, consumers, etc. In the latest earnings transcripts , when CEO James Robo was asked about approval, he stressed that he still believes it will be done by the end of the year: Steven Isaac Fleishman – Wolfe Research LLC Yeah. Hi, everyone. Just further on the Hawaiian deal, what’s the latest in terms of timelines for approval? James L. Robo – Chairman, President & Chief Executive Officer Steve, we’re still hopeful that we’re going to be able to get all regulatory approvals by the end of the year and that’s the target that we’re working towards. Steven Isaac Fleishman – Wolfe Research LLC Okay. Is there any movement toward like settlement discussions or still more formal process? James L. Robo – Chairman, President & Chief Executive Officer I think, Steve, that we’re very early in the process right now and discovery will be ongoing through the summer. And we expect all of the filings to be done by the end of August and so, anything on the settlement front would be very premature. Moray P. Dewhurst – Vice Chairman & Chief Financial Officer Steve, just data; we filed formal testimony. I think we’ve had some 300 interrogatories or data requests so far. We can expect to have a lot more over the coming months. That’s good. We want to make sure that all legitimate questions are appropriately aired and that people get the answers to the questions they have because we firmly believe this is fundamentally a good deal for folks in Hawaii, customers, as well as for shareholders. So we want to make sure that all the facts come out, but it will take a while and the schedule calls for that to go through the summer. It looks like this summer will be key to briefing the necessary parties, filing all the necessary paperwork, and completing the process. Overall, the process is moving along like most deals with some hiccups but generally fine. One item that did come up was that HE had to extend the shareholder vote to get the majority they needed for the acquisition, which does not necessarily mean that it wasn’t liked by shareholders. Overall, though, we believe this deal is very important to NextEra Energy. As we noted previously: The company brings the expertise of how to apply a mix of renewable energy and create consistent returns. With the prices that Hawaii is used to paying, the company should reduce costs for Hawaiians yet also make a strong profit. The company’s mix, though, of more green energy plays has not been as profitable. The company still makes its bread and butter in Florida where it uses a majority natural gas. So, the question will be if they can return the type of 20% operating margin in Hawaii? The nice thing that is baked into the cake for them is that Hawaiians are used to paying more than most Americans, so they will be able to invest more easily. We will continue to monitor this situation, but for now, the company looks like they are still on track. Current Pricing The latest earnings for NEE were pretty solid in the latest quarter. EPS came in at 1.41 versus 1.28 expectations as well as a beat for revenue as well. The company’s results were helped by an improving Florida economy that led to more additions as well as a lot of strength in NextEra Energy Resources, which saw a 41% increase in revenue. The NEER division is the renewable contracted part of the business, and that type of growth shows just how in demand renewable energy is becoming. In this section, we will want to take a look at our last pricing analysis, update it, and determine what we believe is a fair value price for NEE. In order to price the company, we need to make certain assumptions. In our last article, we modeled revenue growth will continue at a clip of 4-5% per year, and we believe that level will maintain for the next several years. The gains in NEER are not sustainable, and a lot of the gains were going up against the very adverse weather conditions one year prior. Most analysts are only modeling for 1% growth still for this year, but we are using an annualized figure. Utility revenue is fairly consistent. The key to the company is definitely margins. Operating margins are key to our DCF analysis. The coming has forecast that they will come in at the 22-23% in 2015, but I imagine this number will dip some with the onslaught of Hawaiian Electric when it is approved. In Q1, the company’s operating margins were strong at 28%. Again, the 42% operating cash flow return at NEER buoyed this higher, and the company stated they see a 20-25% overall operating cash flow return in that division for the full year. For 2015, we believe 22-23% is a bit light, and we will increase our expectation to 25%. As for the HE deal, it should add roughly $4.5B in sales in 2016, but the company operates with a 10% operating margin. The deal is really essentially to take what is a tough market for making money, revolutionize it, and improve it. This plan, though, will take several years. Therefore, margins will drop in 2016 but gradually improve again through 2020. Taxes have averaged roughly 25% for the past five years, and it’s likely this will stay around 28%-30% over the next several years. We may see it jump even a bit more beyond 2016 when more solar credits are expected to expire. Depreciation will continue to grow at about the same rate as revenue growth. Capex should come down in 2015 to around $6B and again in 2016 to $4B.The $4B rate, though, is pretty standard for the company. Our WACC rate is 5% for discounting. When we use this math in our five-year DCF analysis, we were looking at a low-90s number. We have made some positive adjustments, and here is our projections:   PROJECTIONS   1 2 3 4 5   2015 2016 2017 2018 2019 Income from Operations 4350 3654 3990 4347.2 4726.73 Income Taxes 1218 1023.1 1117.2 1217.2 1323.48 Net Op. Profit After Taxes 3132 2630.9 2872.8 3130 3403.25             Plus: Depreciation 2600 2700 2800 2900 3000 Less: Capex -3600 -3900 -4000 -4100 -4200 Less: Increase in W/C -100 -100 -100 -100 -100 Available Cash Flow 2,232 1,531 1,773 2,030 2,303 When we complete the math here, we are now looking at a $96 price tag. The key areas to contemplate are how much will margins drop when HE comes online and how much growth will it bring about. Further, will CapEx be drastically higher in 2016 as the company invests into the infrastructure? These questions are tough to model, but this model appears to be friendly and mid-to-best-case. Thus, we are still coming in around where NEE is performing today. Conclusion NextEra has interesting catalysts to 2015, but after a tremendous run in 2014, the company looks like its upside may be limited in the near-term. The recent pullback is a sign that the stock has gotten ahead of itself, and valuations are still rich. Right now, we like the stock as a long-term play in safety, but it will only be an income play with limited value upside. Yet, for its socially responsible model, the company presents another interesting dynamic. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Will The Fed Push Back Down GLD?

Summary The FOMC will convene again next week. If the FOMC hints about raising rates anytime soon, this could drag down GLD. The recovery of the U.S. dollar and rise in long-term treasury yields will keep pressuring down GLD. The recent strong labor report brought up the odds of the FOMC coming closer towards raising rates. It also cooled down the gold market. Nonetheless, the SPDR Gold Trust ETF (NYSEARCA: GLD ) is still flat for the year even though the U.S. dollar and long-term yields have picked up again in recent weeks. The FOMC isn’t expected to make any big changes in the upcoming meeting. But the price of GLD could start coming down again if the FOMC even drops a hint about raising rates in its upcoming meeting. The better-than-expected non-farm payroll report along with the sharp rise in JOLTS – number of job openings reached 5.38 million while market expectations were set at 5.03 million – have both driven a bit higher the implied probabilities of a rate hike in September to 33% and for December to 70%. The FOMC will convene on June 16-17 and release the press statement on June 17 accompanied with a press conference and release updated economic outlook. On the one hand, the GDP contracted back in Q1 and inflation is still contained below 2%. On the other hand, the U.S. labor market continues to show recovery, and there are possible speculative bubbles in the housing and stock markets, which could be popped once interest rates start to rise again. In the meantime, even though the FOMC is considering normalizing its monetary policy, this doesn’t mean the M2 isn’t growing – as of May, M2 is up by 5.3% year on year. This higher M2 comes despite the tumble in oil prices in the past few months. But the rise in M2, which is another indication for the changes in U.S. inflation, hasn’t driven up the price of GLD in recent years, as presented in the chart below. Moreover, the core PCE , which is the indicator the FOMC follows, has gone down to 1.2% – the lowest level in over a year. This low level doesn’t vote well for the FOMC to turn hawkish in the coming meeting. (click to enlarge) Source: FRED, Google Finance Despite the rise in M2, the U.S. money base remained relatively flat and rose by only 0.7% year over year. But this hasn’t resulted in a sharp rise in the money base as it was the case back when the FOMC implemented QE1, QE2, and QE3. After ending QE3, the FOMC only continued purchasing new bonds to substitute expiring bonds in order to maintain its big balance sheet. Thus, it would take a 180-degree change in the FOMC’s policy for the gold market to heat up again. The weakness of the Euro and other major currencies mainly due to ECB’s QE program, the Greek bailout talks also play a minor role in keeping the Euro weak, is likely to further drive up the U.S. dollar, which doesn’t help the price of gold or the price of GLD. Another factor that could keep slowly bringing down GLD is the recovery of long-term treasury yields, which have picked up in recent weeks. The correlations among GLD and long-term yields, as seen below, are negative and strong and suggest that if yields keep rising, GLD could also start to come down. (click to enlarge) Source: U.S Department of Treasury and Bloomberg Final note The upcoming FOMC meeting could be another nail in the gold market’s coffin – especially if the FOMC turns more hawkish by improving its outlook and providing a clearer picture about raising rates. Currently, the market doesn’t expect the FOMC to make any major changes to the policy and the Fed could remain dovish, which helps to keep GLD from tumbling. The major shift is only likely to occur closer to the end of the year – when the FOMC is more likely to raise rate, assuming the U.S. economy continues to progress in its current pace. Until then, the stronger U.S. dollar and higher long-term treasury yields are likely to keep GLD slowly dwindling. For more, please see: 3 Questions About Gold Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Rate-Sensitive, Energy-Sensitive Sectors Now Down 10%-Plus

Flashy sub-segments like cyber-security and biotech continue to soar. Yet the belief that U.S. equities can stampede ahead indefinitely is sheer lunacy. Several rate-sensitive areas have already entered 10%-plus correction territory. Bullish borrowers have increased their margin debt to invest in stocks from $445 billion in January to $507 billion today. And why not? The overall price movement for growth sectors of the stock market remains healthy. Flashy sub-segments like cyber-security and biotech continue to soar. For example, I allocated a small portion of moderately aggressive client assets to the PureFunds ISE Cyber Security ETF (NYSEARCA: HACK ) in early February. Its series of higher lows since its inception lent credibility to the notion of adding dollars to the high growth, high reward area. Yet the belief that U.S. equities can stampede ahead indefinitely is sheer lunacy. Consider the reality that exports have been tumbling, labor productivity has been stalling and inventories (supply) have been rising significantly faster than sales demand. No matter how the media spin it, the economy is hurting. Now factor the economic headwinds into current and/or future corporate profits and revenue. What do you get? You come up with some of the highest price-to-sales (P/S), price-to-book (P/B) and price-to-earnings (P/E) ratios in the history of stock market valuation. Who cares, right? “Follow The Fed” advocates argue that global central banks have orchestrated exceptionally easy terms for borrowing, making bonds unattractive and stocks the only place to stash money. They maintain that modest rate increases amount to little more than moving from ultra-accommodating policy to extremely accommodating policy. Still, amateur historians might wish to recount that rate hikes in questionable economic environments (e.g., 1929, 1948, 1980) were met with recessions and stock market bears. Others might want to address the historical truth that the epic collapses of the previous decade (i.e., 2000-2002, 2007-2009) occurred alongside a Fed that had been cutting rates aggressively. Might I be more inclined to yield to a “don’t fight the Fed” reasoning if the 10-year were pushing 1%? I imagine I would be buying the harsh pullback that likely occurred along the way. If the 10-year were hugging 2%? I might expect stocks to hold serve. In contrast, the higher the 10-year climbs due to fears of an imminent tightening campaign, the more likely rate-sensitive stock assets will drag the broader market downward. Remember, the S&P 500 has not witnessed a 10% correction in roughly four years. On the other hand, several rate-sensitive areas have already entered 10%-plus correction territory. Real estate investment trusts in the Vanguard REIT Index ETF (NYSEARCA: VNQ ) are off -11.4%, while utilities in the SPDR S&P Sector Select Utilities have dropped -13.2%. The hardship in the energy arena has been equally challenging. Broad-based energy corporations in the Energy Select Sector SPDR ETF (NYSEARCA: XLE ) may be well off their March lows, but the influential sector fund is still down a bearish -21% from a 2014 pinnacle. Similarly, the JPMorgan Alerian MLP Index ETN (NYSEARCA: AMJ ) – hit by the double whammy of rising yields and price depreciation in crude/natural gas – currently resides in a bear cave with a -21.5% decline. Even the transporters in the iShares Transportation Average ETF (NYSEARCA: IYT ) has witnessed intra-day depreciation of -11.5%; the current price of IYT is also below a long-term 200-day moving average. For the record, I believe the bond rout is closer to running its course than marching forward. There is not much technical support for my belief, other than oversold Relative Strength Index (RSI) indications. Support for the 10-year Treasury in and around 2.5% may even be a decent entry point for government bond investors. Consider the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ). The U.S. 10-year is trading 10 basis points lower at 2.4% on Thursday. If you had a choice between owning Spain’s 10-year sovereign debt at 2.1%, Germany’s 10-year bund at 0.9%, or the U.S. 10-year at 2.4%, which would you choose? (Note: I recognize that many would choose “None of the Above.” Nevertheless, foreign investors, pension funds and central banks all require government debt; the supply is limited. The dramatic taper tantrum in bonds that occurred in 2013 reversed itself in 2014. Similarly, the bond rout to this point in 2015 is likely to see a sharp reversal in the 2nd half of 2015 or in early 2016.) On the whole, depending on the client, cash levels have been raised to 10%-25%. I have lowered stock and fixed income exposure due to the execution of stop-limit loss orders as well as the elevated correlations across asset classes; the elevated correlations make it particularly difficult to protect portfolios with traditional diversification. In contrast, a tactical asset allocation decision to raise cash makes it possible to acquire shares of stock or bond ETFs at lower prices in the future. 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. 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