Tag Archives: utilities

General Electric’s Asset Sales Are Creating A Natural Gas Buy With A Dividend

Summary Black Hills Corporation has announced the acquisition of SourceGas Holdings LLC from GE/Alinda Capital. The Acquisition is a continuation of GE’s selloff of assets in a broader strategy to streamline the firm. Black Hills expects the purchase to increase their customer base by 55%. That kind of increase in business is going to have real effects on their earnings per share. What’s Going On? I have written previously about General Electric’s (NYSE: GE ) continued exit from the Finance industry. Most recently, Black Hills Corporation (NYSE: BKH ) has announced its acquisition of SourceGas Holdings LLC. SourceGas is managed by GE energy Financial Services and Alinda Capital Partners. SourceGas has 4 utilities in the United States that serve over 400,000 customers in the western United States. It also has a 512-mile intrastate natural gas pipeline that operates in Colorado. SourceGas was created in 2007 when GE and Alinda Capital made a purchase from Kinder Morgan Inc. (NYSE: KMI ). What’s So Good About It? The $1.8 billion deal is a continuation of General Electric streamlining its business. I am a continued advocate that a streamlined General Electric focusing on its core strengths is going to be a great business to own. The firm will be much better situated to react to economic changes in a timely manner. This acquisition also brings a whole new investment into play. It is a sweet deal for Black Hills Corporation. The firm is no slouch to begin with. The past three years have seen growing net income, improving balance sheets, and improved cash flows. The SourceGas Holdings purchase will increase Black Hills’ customer base by 55% . The company has noted that the effective purchase price will actually be lower due to tax benefits incurred by the acquisition. This is a continuation of the progressive integration of 19 utility systems in the last 10 years. President and CEO David R. Emery spoke strongly about the acquisition strengthening the growth of Black Hills. “SourceGas is a great strategic fit, adding to our strong utility base and providing operational and financial benefits to all the customers and communities we serve. We are excited to significantly expand our presence in Colorado, Nebraska, and Wyoming, and look forward to serving customers and developing new relationships in Arkansas. The transaction continues our proven record of growth in the utility business through targeted acquisitions — over the last decade, we have successfully integrated 19 electric and natural gas systems in support of this growth strategy.” For a utility firm like Black Hills, the importance of natural gas purchases cannot be stressed enough. Natural Gas officially surpassed coal this week as the largest US electric source. The move to buy SourceGas is part of a bigger strategy for the firm to diversify its power sales due to declining wholesale volumes . Stacy Numeroff (an analyst at Bloomberg) noted that “gas utilities do not face the same threats to load growth from distributed generation as their electric counterparts.” It is very encouraging that the utility firm is working to get in on the better growth offered in gas utilities. It is also worth noting that while Black Hills has experienced declines in power sales over the past few years, their net income has increased every year since 2011 demonstrating management’s ability to react to market moves. The one concerning thing about Black Hills’ acquisition is the $720 million that will be added to their current $1.2 billion in debt. The 55% increase in their customer base seems positive enough to let this debt be acceptable, but it is still a concern. As of now, the deal is expected to be completed in early 2016. Mark Maloney (a manager at Manulife Asset Management LLC) pointed out that “Black Hills has a strong track record of accumulating small utilities over the years and they’ve been very successful.” Do You Invest? In the last seven quarters , Black Hills has had 5 earnings beats, with one miss. The question is whether or not the acquisition of SourceGas is going to have a positive effect on earnings per share. The company has stated that it will add “meaningfully” to earnings. With the SourceGas deal increasing its customer base by more than half, I don’t see how it can’t have awesome outcomes for earnings per share. It’s worth noting that 1-year earnings per share growth is already ahead of its 5-year growth rate. The P/E is right along with the Multiline Utilities average, so Black Hills is not costing you any premiums. The 1-year price target of $55.50 seems obtainable if this deal plays out. If you can stomach the debt situation, good net income, improving balance sheets and cash flows on top of the growth potential from this acquisition make for a nice future play with a 3.5% yield cherry on top. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (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.

RWE’s Share Price Bounce Should Be Short-Lived

The German government’s final decision on coal plants is favorable for RWE. Old plants will receive capacity payments. But there will be a very limited power price impact. The shares trade in line with the sector despite weaker profitability prospects and a less attractive dividend. I expect the short-term bounce to reverse. RWE’s ( OTCPK:RWEOY ) share price has risen 7.5% on the back of the German government’s final decision on coal plants . The government had previously proposed legislation for a levy on old coal plants that would have meant a de facto shut down. RWE’s plant would have been the main casualty. As a result of fierce opposition, the Economic Ministry has amended the draft bill and published a revised decision. The final decision is favorable for RWE for several reasons. There will not be any forced shut down of coal plants. And 2.7GW of old coal capacity will be brought into a strategic reserve from 2017. Effectively, they will be mothballed. But they will receive capacity payments. The CO 2 emission reduction of 22mt by 2020 that is targeted by the government should be achieved through new combined heat and power, as well as gas plant builds. I expect RWE to furnish the bulk of the plants that will be brought into the reserve. RWE is the most important coal-based power generator in the country, followed by E.ON ( OTCQX:EONGY ) and Vattenfall. It also has some of the oldest coal reactors in the country. The exact amount of the capacity payments is as yet unclear. But the industry has reportedly demanded eur 300/kW pa. That would correspond to an implied load factor just short of 60%, according to my gauge likely above current achieved load factors. The plant in question was already running at very low load factors and not likely cash flow positive. The remunerated shutdown will therefore be marginally positive. But in the greater context of things, it is worth noting that this makes up no more than 6% of RWE’s overall fleet. I estimate an impact on German power prices in the order of eur 2-3/MWh long term through limited positive merit order effects. But that is, by far, not enough to make RWE’s plant profitable. Furthermore, over time, the impact will get eroded again from more renewables builds. The German power market is severely oversupplied, and any plant other than renewables and a low-cost lignite plant is running on very weak utilization rates. My model suggests that even with the mothballing, the market will remain in firm oversupply. For more detail on the impact on RWE, see my previous article: ” German Government Provides Relief For RWE .” As a whole, the key feature in RWE’s investment case is its struggle with weak power prices and low utilization rates of its generation plant. The reason is its very coal heavy fleet. About 40%-45% of the company’s plant is currently not cash flow positive. The company is looking to shift the company’s profile toward decreasing the weight of conventional power generation and increasing the weight of renewables, supply, and regulated activities. But as I have argued before , even though I see that strategy as positive, it will take a long time still to make a meaningful impact on the company’s earnings profile. With all of the above, I see the rebound on RWE’s share price as short-lived. The shares now trade at a P/E of 12.7x 2016E, which is in line with the sector despite the company’s weak profitability outlook. The same holds true for the 4.5% yield. The impact of the positive news is not large enough on earnings for a major re-rating. RWE has said it may not rule out an E.ON-style split any longer. That might offer a prospect of share price recovery, but investors should keep in mind that E.ON’s generation business is significantly more attractive. I expect E.ON to resume its outperformance over RWE. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (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.

U.S. Regulated Utilities Sector Is Fairly Valued At Current Levels

Summary Weakness in natural gas/power prices to continue for the next 3-4 years. On-going coal retirement plan to have a negligible impact on natural gas prices. Stringent environmental policies may lead to structural changes in the utilities sector. Consolidation of utilities sector continues for the next 2-3 years. In 2014, utilities sector was one of the best performing sectors in the S&P 500 but much of that outperformance has eroded since the beginning of 2015. Key economic indicators such as job market, inflation and Fed rate increase have put significant pressure on utilities stocks. I expect utilities sector as a whole to underperform and investors need to be choosy in the sector before investing. Weakness in natural gas/power prices to continue for the next 3-4 years The weakness in natural gas prices is expected to continue for the next 3-4 years given oversupply, continued operations of cash strapped nuclear plants and on-going coal retirement plans. The natural gas production in South West and North East Marcellus has increased significantly. PJM forward gas prices trade at a discount to Henry Hub as the production especially in Marcellus has already outpaced the capacity reduction. Lack of pipeline infrastructure projects from the companies and strong production growth should maintain the current trend for the next 3-4 years. Recently EIA has also increased the natural gas production outlook for 2015 and 2016 by around 1bcf/day. I believe the on-going coal retirement plan impacts the natural gas prices slightly and not enough to impact forward prices. On the downward side, higher penetration of renewable energy resource will offset any increase in demand for gas due to coal retirement. US Federal has also asked certain cash-strapped nuclear power plants to continue running for some more time (earlier intended to shut down for economic reasons) that would create downward pressure on natural gas prices. Most of the utilities hedge for the short term but in the long-term they will be under greater risk. I don’t see any decrease in gas prices from the current level going forward. The most impacted to forward gas prices are the base-load generators such as American Electric Power Company (NYSE: AEP ), Exelon Corporation (NYSE: EXC ) and Entergy Corporation (NYSE: ETR ) that use only coal and nuclear energy for power generation. These companies look less competitive in a low gas price trend. On the power prices, electric utilities industry is estimated to experience a weak or negative electric demand growth in the next 2-3 years. PJM West is currently oversupplied making the power prices different than in PJM East. I believe some supply from PJM West will be transferred to capacity-constrained PJM East and over a time the difference should dissipate. On-going coal retirement plan to have a negligible impact on natural gas prices Due to stringent environmental policies such as MATS and 111D of Clean Air Act power for CO2 emission reduction, utilities have been asked by the Federal Energy Regulatory Commission (FERC) to retire certain coal assets that are not economical and environment friendly. Around 60-70GW of coal capacity is expected to be retired in the next two years. I believe the bulk of retirement to happen from mid 2015 to 2016. As mentioned earlier, the impact of coal retirement on gas prices is very negligible given the high rate of gas production growth, continuous operations of nuclear plants and renewable penetration. As per Energy Information Administration (EIA) estimates, the contribution from coal energy to national power generation will go down to 30% from the current level of 45% once all the coal retirement is done (expected by 2019) and the contribution from natural gas will increase to 40% from the current level of 23%. Stringent environmental policies may lead to structural changes in the utilities sector 111D of the Clean Air Act: In 2014, Environmental Protection Agency (EPA) released proposed CO2 (Carbon) reduction targets that would reduce carbon emissions for existing coal plants (in utilities sector) around 19% in 2030 from 2012 levels (30% reduction from 2005 levels). While I expect a final rule from EPA by August 2015, it will require each state to submit a SIP (State Implementation Plan) by mid-year 2016 for compliance. Each state will be required to meet its specific targets starting in 2020 through 2030. MATS (Mercury and Air Toxics Standards) : MATS sets standards for Mercury and other air toxics generated by coal and oil plants that are larger than 25MW. Everyone will need to comply including investor-owned utilities and public power utilities. The objective of the Standard is to bring old power plants to new technology. With the current gas price environment, these plants are uneconomical to rejuvenate. As mentioned earlier, certain cash-strapped nuclear plants have been asked to continue running though they are not economical under the depressed natural gas prices. The main reason was to provide room for states to adhere to Clean Air Act. Allowing nuclear plants to shut down will make it more challenging for states to meet stringent requirements and create capacity constraints. Under depressed gas prices, nuclear plants look uneconomical Under depressed natural gas prices, running a nuclear power plant has become uneconomical for utilities. The quark spread (power price minus uranium cost) has consistently decreased over the past few years. However the US Federal asked utilities companies to keep running certain nuclear assets to make room for retiring coal assets. Under the policy, I believe few utilities benefit and few others loose in the short run. A clear beneficiary is base-load nuclear operator EXC and looser is base load coal operators like First Energy (NYSE: FE ). Consolidation of utilities sector continues for the next 2-3 years Under the weak economy, utilities are thirsty for growth. The industry has seen a lot of acquisitions recently (few are mentioned below). I expect the industry consolidation to continue for the next 2-3 years as there is going to structural changes in the industry due to new regulations. Acquirer Target Deal status Duke Energy Progressive Energy Completed NRG Energy GenOn Completed Teco Energy New Mexico Gas Completed Berkshire NV Energy Completed Fortis UNS Completed Exelon Pepco Pending Source: Google I believe the utilities mainly look for targets that are small/mid cap utilities, having exposure to renewable energy, under single state jurisdictions and having good regulatory construct. Future deals will be mainly towards acquiring growth, improving acquirer’s earnings profile etc. Over the last 2 years, multiples paid for acquiring utilities were in the range of 18x-24x. As the utilities are currently trading in the range of 13-15x forward earnings, they look very attractive for any takeover bid. On the other side, utilities are reducing exposure to non-core assets (merchant power generation assets). Given highly volatile commodities market, merchant power generation assets look unworthy for the investors. In order to improve multiples for the regulated assets, power companies have been forced to sell merchant assets. I believe generating assets in a bleak power cycle are worth more in a regulated environment than in pure-play independent power producer (IPP). In last 2 years, we have seen EXC, FE, PPL, DUK and NEE selling their merchant generation business. Who will be potential sellers now? FirstEnergy and American Electric Power are two potential sellers of their merchant assets. Both have publicly confirmed that an outright sale of their merchant generation is highly likely. Solar energy to support capacity reduction due to coal retirement Solar energy should continue to play an important role within the utilities industry. Most of the companies that declined to adapt to solar energy earlier have already started to spend on solar energy assets. Solar growth will remain healthy going forward as utilities: (1) see solar energy as highly economical, (2) look for fuel diversification, and (3) meet legislative mandates. With utilities retiring significant coal assets and nuclear viability continuing to face headwinds, the companies have been highly dependent on natural gas. As the natural gas is highly volatile federal level and state level regulators have been in significant pressure to look find alternative viable energy source. The time has come for utilities to diversify their generation assets (adding solar capacity) and reduce the volatility and any unexpected surge in gas prices. On the negative side, solar will slowly start gaining momentum and steal volumes from utilities at the peak time of the day when generators make the most margin. New capacity performance auction to reward utilities that adhere to auction rules PJM capacity market ensures long-term grid reliability by procuring the appropriate amount of power supply resources needed to meet predicted energy demand three years in the future. Increased outages during the 2013/2014 polar vortex triggered FERC to change capacity regulations (mainly in the upcoming auction regulations for 2018-2019 planning year) in order companies to strictly adhere to stipulated supply. In extreme weather conditions, power generators were impacted with mechanical issues and natural gas supply interruptions. PJM claims that the existing capacity bid offers set at the avoidable cost rate (ACR) are unable to secure reliable capacity. In order to secure reliable capacity, PJM has introduced a new capacity performance (NYSE: CP ) resource product with higher rewards and penalties. Upcoming capacity auction timeline PJM is holding two transitional auctions for 2016/2017 and 2017/2018 this summer. The first will take offers July 27 and 28 and results will be posted on the 30th Jule. The auction for 2017/2018 will take offers August 3 and 4 and results will be posted on August 6, 2015. Work for the 2018/2019 auction will start later this month, but it is being held from August 10-14 and the results will be announced on August 21, 2015. Regulated utilities look fairly priced There seems to be an inverse correlation between bond yields and forward P/E multiples of utilities companies. I expect the interest rates to start picking up from 2016 but not until the presidential elections. Regulated utilities I have valued regulated utilities based on 2016 P/E multiple. From the industry point of view, utilities look fairly valued. Given regulated utilities trading at 15.0x forward 2016 earnings (in line with their fundamentals), we see minimal price upside for the sector as a whole. However, investors could expect an average dividend yield of 4%. I would recommend investors to be choosy in investing in to utilities. Utilities such as PPL and GXP look very attractive at their current levels. Independent power producers (IPP) I have valued merchant assets based on EV/EBITDA multiple. The average multiple for the industry is 8.3x that indicates most of the (TLN, CPN and NRG) independent power producers are trading at low levels indicating good entry point for the investors. Market Current P/E Dividend Yield Regulated Utilities Cap, $bn Price, $ 2015E 2016E 2017E 2015E 2016E 2017E American Electric Power Co Inc AEP 27.2 55.56 15.8x 15.0x 14.2x 4.5% 3.9% 3.9% Consolidated Edison Inc ED 17.8 60.81 15.4x 15.2x 14.6x 4.2% 4.3% 4.4% Dominion Resources Inc/VA D 40.9 68.96 18.6x 17.8x 16.9x 5.1% 4.9% 4.6% DTE Energy Co DTE 13.9 77.51 16.7x 15.8x 14.8x 3.6% 3.8% 4.1% Duke Energy Corp DUK 51.4 74.37 15.9x 15.1x 14.3x 4.4% 4.5% 4.7% Edison International EIX 18.9 57.95 16.1x 14.9x 13.8x 2.9% 3.2% 3.6% Eversource Energy ES 14.9 46.89 16.4x 15.4x 14.6x 3.6% 3.8% 4.1% Great Plains Energy Inc GXP 3.9 25.30 16.7x 13.8x 13.3x 4.0% 4.3% 4.7% NextEra Energy Inc NEE 45.1 101.64 18.0x 16.7x 15.8x 3.0% 3.3% 3.5% PG&E Corp PCG 24.5 51.12 14.8x 13.5x 13.7x 3.6% 3.8% 4.1% Pinnacle West Capital Corp PNW 6.7 60.32 15.7x 15.0x 14.3x 4.0% 4.2% 4.4% PPL Corp PPL 20.7 31.03 14.2x 13.6x 13.3x 4.9% 5.0% 5.1% Southern Co/The SO 39.4 43.36 15.3x 14.8x 14.3x 5.0% 5.2% 5.3% TECO Energy Inc TE 4.3 18.44 16.8x 15.6x 14.5x 4.9% 5.0% 5.1% Westar Energy Inc WR 4.8 36.56 16.3x 14.9x 14.5x 3.9% 4.1% 4.4% Average 16.2x 15.1x 14.5x 4.1% 4.2% 4.4% EV/EBITDA Dividend Yield Independent Power Producers 2015E 2016E 2017E 2015E 2016E 2017E Calpine Corp CPN 6.5 17.37 8.9x 8.8x 8.5x NRG Energy Inc NRG 7.3 21.76 8.4x 8.8x 9.5x 2.7% 3.0% 3.3% Talen Energy TLN 2.2 17.26 7.3x 7.4x 7.8x Average 8.2x 8.3x 8.6x 2.7% 3.0% 3.3% Source: Google Finance Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (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.