Tag Archives: utilities

Duke Energy And Southern Company Set To Soar In 2016

Unregulated utility companies’ performance likely to stay challenging in 2016 because of weak and volatile power prices. DUK and SO making correct strategic attempts to strengthen regulated operations. Stock valuations for DUK and SO are cheap, as both are trading at discounts to peers and the industry average. 2015 has been a tough year for the U.S. utility sector, mainly because of concerns regarding the Fed interest rate increase; the utility sector ETF (NYSEARCA: XLU ) is down 10% year-to-date. Moving into 2016, given the decline in the power and natural gas prices, U.S. unregulated utility companies’ performance will stay volatile and weak; however, I think U.S. utility companies with significant and growing regulated business operations will stay an attractive investment option for income-hunting investors. Duke Energy (NYSE: DUK ) and Southern Company (NYSE: SO ) are the two U.S. utility companies that have large regulated business operations and are further working to strengthen their regulated business operations, which will provide stability to their revenues and cash flows, and support dividend growths. Moreover, valuations for both the stocks stay compelling. Two Utility Stocks: DUK and SO In recent years, low power and natural gas prices has adversely affected performance of unregulated business operations. As the power and natural gas prices continues to stay weak, I think, 2016 will be another challenging year for the unregulated utility companies. In the volatile unregulated business environment, the U.S. utility companies are working to lower their unregulated business operations, which will positively affect their performance. DUK is among the leading utility companies of the U.S., and has been working to strengthen its regulated business operations by making regulated capital investments; the company is expected to make capital investments of $20 billion in the next four years, which will result in increase in its rate base and support earnings growth. The company is not only upgrading its existing regulated infrastructure, but also diversifying the power generation assets by focusing on renewable energy sources, which will improve its business risk profile and allow it to comply with changing environmental regulations. DUK plans to spend to $3 billion on renewable energy in the next four years. Moreover, in 2016, if the company decides to sell its international unregulated business operations, it will positively affect its stock price and will make its cash flows more stable. Also, once the company successfully closes acquisition of Piedmont Natural Gas (NYSE: PNY ), which is consistent with its efforts to grow regulated earnings, it could opt to undertake more regulated gas business acquisitions to strengthen its gas business. Given the company’s aggressive efforts to strengthen its regulated operations, its cash flows will improve, which will allow it to increase its dividend growth consistently in the coming years. The stock has yield of 4.75% , which is supported by its 14% operating cash flow yield, and makes it an impressive investment option for income investors. Also, investors should keep track of yearly earnings call in February, in which the company will provide update on its 5-year growth expectation, synergies related to PNY acquisition and rate case outlook. Southern Company is another utility stock which stays an attractive investment option for income investors, as it offers a solid yield of 4.7% , which are backed by its operating cash flow yield of 15% . The company generates almost 90% of its earnings from regulated operations, which provides stability to its cash flows. Similar to DUK, SO also is working aggressively to modernize and strengthen its power generation assets. Moreover, once the company’s two construction projects, Kemper and Vogtle Power plants, are completed it will portend well for its long-term earnings. Also, the company has been actively increasing its renewable energy asset base. The company spent more than $2 billion on renewable in 2015, and plans to spend another $1.3 billion in 2016, which is expected to increase its renewable energy portfolio capacity to 2,600 MW. Consistent with its renewable generation assets base growth, the company acquired almost 600 MW of solar assets from First Solar (NASDAQ: FSLR ). And also, completion of SO’s and AGL Resources (NYSE: GAS ) in the later half of 2016 will augur well for the stock price. The company’s efforts to improve its regulated power asset base will support its long-term earnings growth, and its business risk profile will improve, as it will complete pending acquisitions and ongoing construction projects. Also, the company’s cash flows will stay strong to support its dividend growth, which will improve investors’ confidence. Valuation and Summation Unregulated utility companies’ performance is likely to stay challenging in 2016 because of weak and volatile power prices. However, companies like DUK and SO, which are making correct strategic attempts to strengthen their regulated operations, will deliver healthy performances in future years. Both DUK and SO offer solid yields of 4.7% and 4.75%, respectively, which makes them attractive investment prospects for income-hunting investors. Moreover, stock valuations for DUK and SO are cheap, as both are trading at discounts to their peers and the industry average. DUK and SO are trading at forward P/E of 14.8x and 15.7x, respectively, versus the utility sector’s forward P/E of 16.5x .

CEMIG: What’s The Weather Like?

Summary CEMIG seems very cheap, but faces several easy-to-spot problems. One of those problems is clearly cyclical and temporary. It’s the weather. Beyond a general overview of the issues CEMIG faces and offering a long-term opinion, this article also considers the importance of the weather in trying to establish a CEMIG position. On paper, CEMIG – Companhia Energética de Minas Gerais (NYSE: CIG ) is an extremely appealing equity. Here’s a utility that has a current dividend yield of 10.6% and trades for 4.4x its 2016 EPS consensus. Sure, CEMIG is in Brazil. And Brazil is in the dumper due to an implosion in commodity pricing (namely crude and iron ore), on which its exports long relied. Also, Brazil’s government budget is slowly turning into a deficit, on account of both the economy and higher social spending: (click to enlarge) Source: Tradingeconomics.com, government budget Plus, of course, CEMIG faces its own travails, having lost 3 hydroelectric concessions which are likely to drive its earnings down by ~50% . And then there’s the fact that CIG is an ADR, reflecting the behavior of CEMIG as quoted in São Paulo … in Brazilian Reais. You see, the real has been doing its best impersonation of a banana republic currency – both on account of the commodity implosion, the resulting economic slowdown and the slowly-eroding budget balance: (click to enlarge) Source: Xe.com There is, thus, a lot of trouble to go around. I could however say there’s one bright spot here on the currency front. While the commodity implosion had a very negative impact on exports, the Real implosion made sure that imports fell hard as well. The end result is that Brazil is still holding on to a positive balance of trade: (click to enlarge) Source: Tradingeconomics.com, balance of trade The main economic risk is thus reduced to the chance that the budget deficit deteriorates so much that Brazil resorts to money printing and turns this manageable situation into a Venezuela . Barring that, we could argue that the Real is fairly valued or even undervalued (if some of the commodity weakness in oil and iron ore goes away). At this point, we could thus argue that taking into account the economic outlook, Real, valuation (EPS consensus) and the loss of concessions, CIG should be at an attractive long-term level. And that would probably be right. But there’s yet another factor. The Weather You see, Brazil is supposedly in the midst of its worst drought in the last 80 years ( I , II ). A drought which was made worse by the weak 2014 rain season (starting in November 2014). Now, a drought here is a serious matter, because Brazil relies heavily on hydroelectric power – and CEMIG relies even more on it (though that will now be reduced by the loss of 3 hydro concessions): (click to enlarge) Source: CEMIG Presentation The drought, as I said, was made worse by a weak 2014 rain season. A drought is clearly a temporary factor, so buying stock affected by it could make sense long-term. But usually, you wouldn’t want to necessarily be doing so right away if you thought that there was still significant pain ahead. In that regard, it pays to check how this rain season is going, as it will affect hydroelectric power generation throughout 2016. We do have a way of monitoring how it’s been doing: Source: NOAA, National Weather Service As it were, the answer about the weather is “not so good”. The most important state for CEMIG is Minas Gerais and the adjoining smaller states, and those are clearly seeing under-average rainfall during this rain season as well. Source: Company Presentation So, for timing purposes, we do know that more fundamental deterioration likely still lies ahead for CEMIG even if the present share levels already look attractive for the longer-term. On The Other Hand CEMIG does get a lot of its profits from generation. But it also gets 1/3rd of EBITDA from transmission, and that ought to be defensible: (click to enlarge) Source: Company Presentation This is yet another factor telling us that, longer-term, CEMIG should be attractive – though it probably won’t mitigate further short-term fundamental weakness coming from the weather. Conclusion Some of the problems CEMIG faces are structural, like the loss of 3 important concessions. Others seem discounted, like the massive Real plunge (unless the government goes all Venezuela on us). Taking into account these problems and the earnings impact, it would look like CEMIG is already at an interesting level for longer-term investments (the 2016 EPS consensus puts the company at 4.4x earnings, and should already account for the concession losses – but not for further fundamental deterioration). However, to further refine the timing of buying CEMIG shares, one of the largest problems with CEMIG remains, though it’s clearly cyclical and temporary. I’m talking about the weather. On that front, it looks likely that the fundamental newsflow over the next 3-9 months will remain rather negative – since if it’s not raining a lot right now, it will be hard to compensate for most of 2016. On this account, it might also happen that CEMIG will further cut its dividend or entirely eliminate it (temporarily) – which is another possible “ugly newsflow” event. Putting it all together, CEMIG is trading at an interesting long-term level given the depressed valuation. Weather considerations are mainly for trying to establish the best possible entry point, in spite of the stock already looking attractive long-term.

American Electric Power Raises Dividend 5.7%… What Now?

Summary For a utility, AEP’s record of dividend hikes is impressive. However, I suspect growth will be smaller in coming years as the ‘shale boom’ comes to a screeching end. At this time, I believe it’s best to stay on the sidelines on AEP. As a dividend investor, I tend to like utilities. But ‘climate change legislation’ has kept me away from most utilities. Solar and wind energy are expensive relative to fossil fuels. While utilities may ultimately pass those costs on to consumers, utility companies will have to invest a lot of money into new transmission and generation infrastructure. That means lots of new debt, with no significant demand growth: A very bad combination. When I look for utility companies, I look for ones that operate in states which have minimal or no ‘renewable energy mandates.’ I therefore tend to stick with US-based utilities because the US has some of the most reasonable energy policies of the developed world. I also tend to stick with select states where mandates are the lowest. American Electric Power (NYSE: AEP ) is one of the utilities I like. It operates mostly in Ohio, West Virginia, Texas and Oklahoma. While AEP has been increasing its renewable share of power, the numbers remain quite reasonable. Have a look. (click to enlarge) Courtesy of AEP Investor Relations. Even by 2026, only 15% of AEP’s total generation will be from ‘renewable’ energy sources. That’s pretty good. Of all the country’s utility providers, AEP’s generation is among the most economical. Back on November 6th, AEP paid a dividend of 56 cents, which is 5.7% higher than the previous quarterly dividend. For a utility, that’s quite an impressive growth record. That dividend growth has been mirrored by earnings growth. Between last year, this year and next year, AEP expects 4%-6% earnings growth, and the company is making good on that promise thus far. (click to enlarge) Courtesy of AEP Investor Relations. Where is that growth coming from? Well, it’s coming from capital investment, ‘rate recovery’ from investment in fully-regulated assets, and also cost savings. Each account for a good part of AEP’s earnings growth. Courtesy of AEP Investor Relations. A big advantage that AEP has lies in its location. AEP operates in the Eagle Ford, Permian, Marcellus and Utica shales. These territories have been hot-spots for growth over the last few years. Have a look. Courtesy of AEP investor relations. As you can see, industrial load growth in shale areas has far outpaced the rest of the company’s industrial base (and, indeed, the rest of the country in general), even though crude prices have fallen by 60% and rig counts have dropped by over half. This juxtaposition exists because the number of wells drilled per rig has increased dramatically, and the build out of midstream infrastructure has lagged behind the drop in activity. So, does the ‘shale boom’ live on? I don’t think so. Judging from both the comments and actions of OPEC kingpin Saudi Arabia, it really looks as if crude oil prices are going to stay low. But will production in these regions continue to remain stubbornly high? I really don’t think so. In 2016, the hedges of most shale-based E&Ps will roll off. This will ultimately lead to smaller lines of credit, and much less access to capital for these E&Ps (junk bond yields have risen sharply). With credit markets squeezed, I believe that small-sized and even medium-sized shale drillers will find it difficult to continue drilling at some point next year. Energy activity is lagging behind the oil price, but that drop is already coming. Therefore, I really believe that AEP will find it shale-area industrial growth coming to a halt next year. There’s a good chance it could even go negative. Courtesy of AEP Investor Relations. In fact, we can already see that industrial sales growth in shale regions has already pulled back significantly over the last few quarters. Expect much more of this. All things considered, earnings growth is probably going to slow down as a result of this. By how much is difficult to estimate. However, as the energy crisis deepens and takes a bite out of the economies of Texas, Ohio and Oklahoma, overall employment and GDP numbers in AEP’s service areas will underperform the rest of the country. In fact, that’s already begun to happen. (click to enlarge) Courtesy of AEP Investor Relations. Overall, AEP’s total electricity sales are scheduled to increase 0.6% in 2015, and that should translate to 4%-6% earnings growth. Next year, and indeed the years after, will be more challenging as long as crude oil prices remain low. While low oil prices are good for the country as a whole, they do effect AEP’s service areas. That is apparent when looking at the above right chart, where ‘AEP West’ represents both Texas and Oklahoma. Going forward I expect to see considerably slower EPS growth; perhaps something more like 2% or even less, because AEP’s operating territory is about to be hit hard, especially Texas. Overall, AEP will be fine because it is a diversified, regulated utility, but the company’s engine of growth is going to peter out soon. Therefore, I expect tamer dividend growth going forward. Is AEP a buy? Is AEP worth buying here? I would be cautious on this. According to data from FAST Graphs, AEP’s ten-year average price-to-earnings ratio is 13.7 times, but right now the company trades at 15.8 times. As a utility, AEP is also somewhat exposed to higher interest rates. If bonds trade lower, chances are AEP will follow. Right now, as with many stocks, caution is warranted with AEP. Those wanting to pick up a utility should instead look at Entergy Corp (NYSE: ETR ), which is benefiting from the petchem boom along the Louisiana and Texas coasts. That growth story is still somewhat intact.