Tag Archives: utilities

Should You Stick With Duke Energy After A Rough Year?

Duke Energy has received the first two regulatory approvals to proceed with its acquisition of Piedmont. The annual average residential electricity sales will drop 0.5% in 2016, but the prices increase will offset the impact of unfavorable weather conditions. Duke Energy is trading at very reasonable valuation and offers a very attractive dividend yield of 4.58% at current levels. Duke Energy (NYSE: DUK ) has received the first two regulatory approvals to proceed with its acquisition of Piedmont Natural Gas (NYSE: PNY ). Now the approval of Piedmont’s shareholders and permission from the N.C. Utilities Commission is required to complete the transaction. So far the process has progressed smoothly, and Piedmont’s shareholders will meet on January 22, for that purpose. Duke Energy will become the largest gas utility in the state and N.C. Utilities Commission could raise concern over the dominance position, but the management expects to complete the transaction on time. Duke Energy, like most of the other utility stocks, underperformed during 2015 primarily due to uncertainty over interest rate hike. Now finally, Fed has raised the rate and would continue to hike steadily during 2016. The only downside of interest rate increase for Duke Energy is that incremental financial burden could restrict the earnings growth. In this scenario, the investor might be concern over the sustainability of future dividend payments. However, consistently growing regulated electric & gas operations and stout cash flow position will enable Duke Energy to bear the shock and continue to return cash to shareholders. So far this year, Duke Energy has delivered satisfactory performance despite very rough weather conditions. In the coming quarters, the outlook of unregulated utilities is likely to remain challenging primarily due to declining power and natural gas prices and soft electricity demand. On the contrary, regulated utilities will benefit from the supportive regulatory environment, resulting in steady operating earnings growth in 2016. While overall sector earnings are likely to grow 3.7% during, Moody’s (NYSE: MCO ) expects that regulated utilities will witness better operating earnings growth. Source: Factset Duke Energy’s regulated utilities segment recorded operating revenue of $17.09 billion, an increase of only $16 million year-over-year. The flat top-line was due to unfavorable weather during the first half of 2015, but the segment revenue increased 2.7% during the third quarter on the back of mid-single digit increase in electricity demand. Currently, the regulated electricity business is 91.3% of total revenue flowed by 6.4% nonregulated and 2.3% regulated natural gas. Going forward, the addition of approximately $1.4 billion annual sales from Piedmont will significantly increase the revenue contribution of Duke Energy’s existing regulate natural gas business. In the advantageous scenario, the aggressive acquisition of regulated assets will fuel the company’s earnings. (click to enlarge) Source: Company Presentation The commercial and industrial demand is steadily rising, but the mild weather is negatively impacting the demand for residential electricity. The Energy Information Administration (EIA) estimates that annual average retail residential sales will drop 0.5% in 2016, but electricity sales to the commercial and industrial sector will increase by 0.7% and 1.4%, respectively. Source: EIA Duke Energy may continue to witness flat residential usage per customers owing to stable demand and improving efficiency level, but an increase of 0.7% in residential electricity prices will support the growth during 2016. Moreover, the diversified customer base and the addition of new residential customer at a low single-digit, the company added 1.3% new customer over the past twelve months, will boost the top-line at a steady pace. On the other hand, the potential ease in currency headwind and divestiture of poor performing assets could also improve the revenue from international operations. Thus, the trickling down of revenue growth, solid gross margins, and a massive $10 billion investment in gas & electric infrastructure will enable Duke Energy to accelerate an average long-term earnings growth of 4% – 6%. Duke Energy pland to invest approximately $20 billion in new generations and infrastructure development between 2015 and 2019. So far, the company has spent $4.64 billion in CAPEX during 2015, while it generated $5.4 billion in operating cash flow with cash & cash equivalent of $1.37 billion cash. The cash flow position looks pretty healthy, which depict that the company would be able to manage CAPEX and dividend payments without any cut if the interest rate increases further. Duke Energy increases dividends each year, and it has paid the quarterly dividend for 89 consecutive years. Duke Energy is one of the high yield utility stocks and currently, it offers a yield of 4.58%, significantly higher than the average 3.90% yield of large-cap electric utilities in the U.S. Duke Energy has increased the dividend at a CAGR of approximately 2% between 2009 and 2014. Now, the company has recently boosted the increase rate to 4%. The management expressed the intention to increase the future dividend more in line with the long-run earnings growth, which is 4% – 6%. Though interest rate is a threat, the healthy balance sheet will enable the company to maintain the dividend growth. Source: Finviz The balance sheet of the company is very sound with total assets of $121 billion. In contrast, the company has a total debt of $40.2 billion. The debt would increase in 2016 owing to partial debt financing to complete the acquisition and additional debt from Piedmont. Despite the substantial debt, the company’s financial health is likely to remain rigorous as it invests in quality assets to generate growing cash flows, and its total debt to asset ratio, excluding goodwill, is only 0.38 times. Currently, the total debt to equity ratio of Duke Energy is 1.07 times, which seems quite high but is significantly lower than the large-cap electric utilities average and median of 1.38 times and 1.21 times, respectively. Moreover, the interest coverage ratio of 3.85 times depicts that Duke Energy is in a very comfortable position to cover the future interest expense while raising the dividend in line with the earnings growth. Duke Energy delights the investors by raising dividends, which are backed by consistently growing earnings. Unfortunately, Duke Energy is one of the stocks to lose double-digit value during 2015 primarily due to interest rate turmoil throughout the year. On the flip side, Duke Energy is now trading at very reasonable valuation, and its yield has increased due to a steep decline in share price. Duke Energy is currently trading at forward PE of 15.31x, which is slightly less than the utility sector forward PE of 15.5x. That said, Duke Energy is a very decent utility stock to hold for growing dividends and investors should not worry about the interest rate as it is already priced-in.

Will Falling Silver Production Start To Impact SLV?

Summary The price of SLV lost 9% of its value during 2015. Silver production may drop in 2015 — for the first time in over a decade. As the deficit in silver keeps rising, this could eventually start affecting the price of SLV. The silver market didn’t have a good year as the price of the iShares Silver Trust ETF (NYSEARCA: SLV ) shed over 9% off its value. The direction of silver will continue to be dictated by the direction of long term interest rates and U.S. dollar (among other things that silver investors look for when investing in the precious metal). But what about the changes in the physical demand and supply for silver? After all, the ongoing low silver prices contributed to the decline in silver production this year – perhaps 2015 will be the first year since in well over a decade, in which production won’t rise. Will this be enough to drive up the price of SLV? I have already addressed the recent rate hike by the Fed and its impact on SLV. Currently, the market isn’t convinced the Fed will raise rates by another 1 percentage point as its members estimated in the last FOMC meeting. The implied probabilities , as collected by Fed-watch, suggest the market projects only two hikes of 0.25 basis points in 2016. If the Fed wind up raising by only 0.25bp or not raise at all, this could bring back down long term interest rates and perhaps even depreciate the U.S. dollar – two shifts that could behoove the price of SLV. What about the changes in production? According to the Silver Institute the balance between supply and demand was in deficit (i.e. the demand was higher than the supply). And this has been the case for the past 12 consecutive years . This year’s deficit is expected to settle at 21.3 million oz – the lowest deficit in a decade. This decline in deficit is mostly due to net outflows from ETFs holdings and derivatives exchange inventories. Basically, as the demand for silver as investment diminishes, it helps ease the physical deficit. But there is also the matter of falling production that could increase this deficit. Up to 2014, production has been rising. This year, however, it seems production hasn’t picked up and perhaps even slightly declined. Among the top leading countries the produce silver: Mexico, Peru, China, Australia and Chile, according to one outlet , total production in these countries is slightly down for the year (up to August) – by less than 1%. So it’s still unclear how the year will end for the silver balance. But even if this year the deficit expands again, it doesn’t mean this trend will be enough to push up the price of silver. The high deficit in recent years including 2013 and 2014 hasn’t helped rally the price of silver. But perhaps this could also be a matter of timing. Eventually the deficit in supply-demand balance will matter enough to pull up the price of silver, especially as silver loses its shine as investment. When will this happen? That’s unclear. Therefore, for the near term it still seems that the direction of SLV will be govern firstly by the changes in the demand for silver as an investment tool and only secondly by the changes in supply and demand for physical silver. This means the direction of the U.S. dollar, other precious metals – most notably gold – and long term interest rates will set the pace for SLV. In the coming months, I won’t be surprised if the Fed takes a more dovish tone than it took in its recent statement, which could actually slightly pull up SLV. Finally, in the medium term, the growing deficit in silver – mostly driven by falling production and rising physical demand – may take a bigger role in moving the price of silver. For more please see: What’s Up Ahead for Silver in 2016?

Consolidated Edison – An Unsettling Look At Shareholder Yield

In a prior commentary I looked at the “shareholder yield,” that is dividends and share repurchases, for Coca-Cola and Exxon Mobil. In both instances the shareholder yield was greater than the dividend yield. Alternatively, a company like Consolidated Edison has a shareholder yield that has been routinely lower than its dividend yield. In a previous article I compared the “shareholder yield” of both Coca-Cola (NYSE: KO ) and Exxon Mobil (NYSE: XOM ). The idea was to take it a step further than simply looking at dividend yield, and instead focus on funds used for both dividends and share repurchases. As a part owner, share repurchases are commonplace. Yet if you owned the entire business, there would be no need to repurchase shares and thus these funds could be diverted elsewhere. For Coca-Cola and Exxon Mobil, this meant that the “shareholder yield” – dividends plus buybacks – was reasonably higher than the ordinary dividend yield that you commonly see quoted. Exxon Mobil turned out to have a higher shareholder yield than Coca-Cola (it’s share repurchase program has more room and a lower valuation of purchased shares) but the takeaway was that both companies had the ability to send away more cash without impairing the business. Which brings us to a company like Consolidated Edison (NYSE: ED ). Unlike Coca-Cola or Exxon Mobil or any number of well-known dividend paying companies, Consolidated Edison’s share count has been increasing over the years rather than decreasing. Thus conversely the shareholder yield tends to be lower than the quoted dividend yield. Let’s look at the past decade to see what I mean: Year Divs Sh Re Shares Total / Sh Price Sh Yield 2005 $518 -$78 245 $1.79 $46.33 3.9% 2006 $533 -$510 257 $0.09 $48.07 0.2% 2007 $582 -$685 272 -$0.38 $48.85 -0.8% 2008 $618 -$51 274 $2.07 $38.93 5.3% 2009 $612 -$257 281 $1.26 $45.43 2.8% 2010 $640 -$439 292 $0.69 $49.57 1.4% 2011 $704 -$31 293 $2.30 $62.03 3.7% 2012 $712 $0 293 $2.43 $55.54 4.4% 2013 $721 $0 293 $2.46 $55.28 4.5% 2014 $739 $0 293 $2.52 $66.01 3.8% The first three numerical columns are in millions, while the next two represent a per share basis. On the dividend front we can see that Consolidated Edison has been paying more and more total dividends, as to be expected from a company with a long history of regularly increasing its payout . What’s not readily obvious until you take a closer look is that the company had been issuing a good amount shares during the 2005 through 2011 period. This makes sense when think about it – the business is inherently capital intensive – but it might not be something that you would instantly notice. As such, the share count has been increasing. The company had 245 million shares outstanding in 2005, which has now become 293 million. This makes a difference when you’re thinking like an owner rather than a small shareholder. Here’s a comparison of the shareholder yield and the dividend yield over the years: Year Div Yield Sh Yield Difference 2005 4.6% 3.9% 0.7% 2006 4.3% 0.2% 4.1% 2007 4.4% -0.8% 5.2% 2008 5.8% 5.3% 0.5% 2009 4.8% 2.8% 2.0% 2010 4.4% 1.4% 3.0% 2011 3.9% 3.7% 0.2% 2012 4.4% 4.4% 0.0% 2013 4.5% 4.5% 0.0% 2014 3.8% 3.8% 0.0% The first number is what you’re accustomed to seeing quoted on any financial website – a dividend yield in the 3.5% to 5% range. The next column – shareholder yield – illustrates what magnitude of cash is actually being returned to shareholders. Consolidated Edison was indeed paying the full dividend, but it was also receiving cash back from shareholders to increase the share count. If you owned Coca-Cola or Exxon Mobil or any number of other firms in their entirety, the amount of cash that would be available to you would likely be greater than the current dividend yield. When a company both pays a dividend and buys back shares, the shareholder yield is greater than the dividend yield. With Consolidated Edison you have the opposite effect take place. The amount of cash that can be extracted from utility-like business models (without impairment) is lessened when you think about owning the entire thing. Issuing shares is common practice in the utility world (and other worlds for that matter) but it likely wouldn’t be occurring if there was just one owner. (You wouldn’t buy more shares yourself, or you could, but that would simply be inputting more capital). Thus you have a couple other options: issue more debt or reduce the dividend payment. The second option is what is being illustrated in a “shareholder yield” way, but the first one is much more common. Incidentally, whether you own all of it or not, this is exactly what we have seen with Consolidated Edison in the past decade. Notice the difference in the 2005 through 2011 period and the 2012 through 2014 timeframe. In the first period you had an increasing dividend to go along with a good deal of shares being issued. In 2007 shareholders received $582 million in dividend payments, but gave back $685 million to add to the share count. You can call the dividend payment yield, but in the aggregate the company was actually a net beneficiary of cash received. The amount of funds available had been quite a bit lower than what the dividend yield alone would indicate. Notably, Consolidated Edison did not issue shares in 2012, 2013 or 2014. Which means that the shareholder yield was equal to the dividend yield in those periods. Yet there was still impairment during this time. The company had net debt issuances of $1.1 billion, $1.4 billion and $1.1 billion during those years. Instead of issuing shares, debt was used – much like what might be required if you owned the business in its entirety. The shareholder yield gives a reasonable gauge as to the type of cash flow that could be extracted from the business, but naturally it’s just a first step in the process. In this instance, it shows that while the dividend has been above average and increasing, the amount of cash than can be taken out of the business without impairment has been consistently lower than this yield. Warren Buffett had a particularly revealing commentary related to this concept (and incidentally Consolidated Edison itself) back in the 1970’s: “In recent years the electric-utility industry has had little or no dividend-paying capacity. Or, rather, it has had the power to pay dividends if investors agree to buy stock from them. In 1975 electric utilities paid common dividends of $3.3 billion and asked investors to return $3.4 billion. Of course, they mixed in a little solicit-Peter-to-pay-Paul technique so as not to acquire a Con Ed reputation. Con Ed, you will remember, was unwise enough in 1974 to simply tell its shareholders it didn’t have the money to pay the dividend. Candor was rewarded with calamity in the marketplace.” “The more sophisticated utility maintains – perhaps increases – the quarterly dividend and then ask shareholders (either old or new) to mail back the money. In other words, the company issues new stock. This procedure diverts massive amounts of capital to the tax collector and substantial sums to underwriters. Everyone, however, seems to remain in good spirits (particularly the underwriters).” Naturally today you can make a bevy of arguments (rock bottom interest rates, for one) that did not qualify back then. However, the concept is similar: the amount of money that can be taken out from owning the entire business is apt to be lower, not higher, than the stated dividend yield. Ideally you’d like to think in “owner’s earnings” terms, but the shareholder yield provides a short cut to get you started. Whereas a company that regularly repurchases shares has a bit of wiggle room (those repurchase funds could be diverted toward sustaining the dividend in dire times) a company issuing shares has the opposite effect occurring. A company that regularly issues shares has “negative” wiggle room. Now I’m not suggesting that Consolidated Edison is a poor business or that it’s bound for doom – far from it. Utilities tend to exist out of necessity and have been churning out cash for decades. However, looking at shareholder yield (and ultimately owner earnings) is a bit of a different way to think about it. If you owned all of Exxon Mobil you could pay yourself a 5% or 8% dividend in regular times and not put an added burden on the business. That is, the quoted dividend yield understates the amount of cash that could be extracted without impairing the company. With Consolidated Edison, this likely isn’t the case. If you owned all of Consolidated Edison, you’d be more likely to see a lower not higher percentage of cash being paid out. No longer would you be issuing shares and thus the focus would turn to added debt or a reduced payout. The debt could go on indefinitely, but the capital necessities are such that the current dividend payment coexists with other pressing requirements. When they say that you’re “buying it for the dividend” this could be even more applicable than it first appears.