Tag Archives: utilities

High-Yield Utility That Has Fallen Off Everyone’s Radar

Summary Brookfield Renewable Energy yields 6.6%, over 1.6% higher than the typical utility that yields under 5%. The company is riding on the mega-trend train of a global growing demand in renewable energy, and the business has the expertise to bank on acquisition opportunities. The business forecasts dividend growth of 5-9% per year through 2020 and a long-term shareholder return of 12-15%. I’m primarily a dividend growth investor. So, current income and growth of that income is important to me. Utilities are typically known for their high yields. So, buying utilities, I expect a good part of returns to come from their dividends. The lower the price goes, the higher the yield climbs. That’s the case with Brookfield Renewable Energy Partners LP (NYSE: BEP ), as it has fallen over 18% from a year ago. (click to enlarge) Compared to most other popular utilities, Brookfield Renewable has performed quite poorly price-wise in the past year. Particularly, I’ve put it in a chart with Consolidated Edison, Inc. (NYSE: ED ), Duke Energy Corp (NYSE: DUK ), WEC Energy Group Inc (NYSE: WEC ), and Southern Co (NYSE: SO ). Source: Google Finance The utility group typically yields in the 4-5% range, and Brookfield Renewable stands out by yielding 6.6%. But, perhaps, that’s because it is viewed as higher risk with an S&P credit rating of BBB, while the others all have a rating of A-. BEP Dividend Yield (TTM) data by YCharts To consider it as a potential utility holding, the question you want answered is probably: “Is Brookfield Renewable Energy’s distribution sustainable?” First, let’s find out if it’s the kind of business you want to own. Business and Assets Brookfield Renewable has started investing in hydropower facilities 20 years ago. Today, it has become one of the biggest public pure-play renewable businesses with global assets. It focuses on accumulating long-life and low-cost assets that will continue generating cash flows. Since it requires deep operational knowledge and marketing expertise to enter the space, there’re significant barriers to entry. Brookfield Renewable has $19B worth of power assets, including around 250 power generating facilities across 14 markets in 7 countries. 81% of its 7,300 MW capacity is generated by hydroelectric facilities with about 18% generated by wind power. Currently, 50% of its assets are in the U.S., 25% are in Canada, 20% are in Brazil, and 5% are in Europe. Not Just an Income Play, But Also a Growth Play Demand for renewable energy has been growing. New investments in renewables around the globe have grown from $45B in 2004 to $270B in 2014, a CAGR of 19.6%. More recently, from 2013 to 2014, they grew at a rate of 16.4%, which is still admirable growth. Specifically, hydro power capacity grew at a CAGR of 4% over the decade, and 3.6% from 2013 to 2014. Although its growth only keeps pace with inflation, hydro power generation is low cost, and is more reliable than wind power generation. On the other hand, wind power capacity grew at a CAGR of 22.7%, and 16% from 2013 to 2014. In the last four years, Brookfield Renewable acquired and developed about 3000 MW, which is a CAGR of about 14%. How Does Brookfield Renewable Grow? Over the next 5 years, Brookfield Renewable plans to deploy over $3 billion of equity, expecting 15% returns. The focus will continue to be on hydro power generation, and acquiring global renewable assets at attractive prices. For example, in 2004, Brookfield Renewable acquired a 600MW capacity pumped storage asset with its 50% joint partner during a period of low power prices for $99M. It then entered into a 15-year contract that creates a predictable cash flow stream. At the same time, it’s not shy from selling for good profit as well. For example, in 2009, Brookfield Renewable acquired an early-stage wind power development project for $90 million. It finished constructing it and optimized operations by leveraging its wind expertise to maximize value. In July 2015, it sold the asset by attracting global bidders and generated an internal rate of return of about 30%. Like it did in North America and Brazil starting in 2011, Brookfield Renewable can continue its value creation process and repeat it in Europe, Latin America, and other new markets. A Safely Growing Dividend As Brookfield Renewable grows, it doesn’t forget to reward shareholders. From the distribution that commenced in 2011, it has grown from a quarterly distribution of 33.75 cents per share to 41.5 cents per share this year, a CAGR of 5.3%. About 90% of Brookfield Renewable’s cash flows have a 17-year average contract term with inflation-linked escalation, so its cash flows remain stable to support its distributions. Further, it targets an FFO payout ratio of 70%. With FFO expected to increase by $220-$280M a year, Brookfield Renewable forecasts distribution growth of 5-9% per year through 2020. Valuation Brookfield Renewable believes it’s intrinsically worth $34 a share even when excluding potential for rising prices, and existing project pipelines. At $25, it is discounted by over 26%. Adding in organic growth, the business believes it’s easily worth over $40 in the future, implying a significant discount of over 37%. (click to enlarge) Source: Brookfield Renewable October Investor Meeting – Slide 35 What Should Be Your Returns Expectation? Other than forecasting distribution growth of 5-9% per year through 2020, the business’s objective is to deliver long-term total returns of 12-15% to shareholders annually. With a current yield of 6.6% and the distribution estimated to grow at least 5%, that implies a rate of return of at least 11.6%, which is close to the low-end of that objective. Conclusion I just added to my position in Brookfield Renewable last week. How about you? Did you buy any utilities recently? Share in the comments below! If you like what you’ve just read, follow me! Simply click on the “Follow” link at the top of the page to receive an email notification when I publish a new article. Resources and References Brookfield Renewable October Investor Meeting ( pdf ) Brookfield Renewable November Presentation ( pdf ) Ren21 Renewables 2015 Report ( pdf )

Duke Is Making All The Right Moves To Secure A Bright Future

Summary Company is taking correct strategic growth measures to ensure secure and sustainable earnings and cash flow growth. DUK can apply for strong rate cases in future due to its high growth investments. Long-term prospects of DUK seem bright due to accelerated growth investments. Company’s risk profile will improve given its measures to strengthen its regulated business. Duke Energy (NYSE: DUK ) is one of the leading electric utility companies in the U.S., which supplies energy to North America using an extensive portfolio of electricity generation assets. The company is regularly using a major portion of its growth investments on expanding its renewable regulated asset base by making regular acquisitions and by pursuing several appealing construction projects, under its attractive business strategy that focuses on having large regulated business mix. DUK’s ongoing capital expenditure will keep its rate base growing, above or in line with the management’s forecasted range, which will boost its long-term earnings and cash flow growth. Given the company’s on-track, strong long-term strategic growth measures, I think income-hunting investors should consider adding DUK to their dividend portfolios. Electricity consumption in the U.S. has been growing at a modest rate. The graph below reflects EIA projections for U.S. electricity consumption in 2016. Source: eia.gov To strengthen their electricity generation portfolio and to keep up with the changing environmental regulations, U.S. utility companies are trying to maximize opportunities of growth, while managing risk by intelligently shifting towards the regulated business side, which will provide stability to their cash flows and earnings. Speaking of DUK, the company has also followed industry norms by increasing its dependence on the regulated business side, which has been a very strong performer. DUK now expects regulated and commercial business to grow by 4%-6% . The company’s plan to have a larger regulated business mix through active acquisitions and through several construction-related projects, is working really well. DUK has built a strong portfolio of approximately 2000MW of owned and equity interest in both wind and solar projects. Speaking of the solar side of its renewable regulated business side, the company is systematically and strategically growing its solar energy-based electricity generation asset base. In North Carolina, where DUK already operates with 13 solar farms, the announcement for the construction of the biggest solar energy generation farm of 40MW , in collaboration with First Solar (NASDAQ: FSLR ), has been announced. Moreover, the company plans to complete the construction of 128MW utility-scaled solar operations in North Carolina. Additionally, DUK’s solar-based investments in South Carolina and Florida are advancing well with the plan. I think the company will benefit from its ongoing investments in the Carolinas by filing rate cases in upcoming years, which will bode well for its EPS and cash flow growth. The company is planning to make its renewable energy generation portfolio stronger, by agreeing on a $4.75 billion deal agreement with Piedmont Natural Gas (NYSE: PNY ). DUK’s management expects that the acquisition of PNY’s assets will be accretive to its earnings base in the first year, after the closure of the deal; the deal will add approximately 50bps to long-term EPS growth. The company is expecting benefit from robust rate base growth of around 9% from this acquisition, which will accelerate DUK’s sales and cash flow base and will ultimately increase its growth rate beyond the given guidance of 4%-to-6%. Moreover, the company has recently acquired a 50% stake in Mesquite Creek via Sumitomo joint venture, to acquire 211MW wind power project, upside of this deal rests in enhancing DUK’s energy generation capacity; also the deal has moved it a step towards achieving its goal of becoming carbon neutral by 2020. Taking another smart move towards achieving carbon neutrality goal, the company has announced the retirement of its Ashville coal plant in N.C. and its replacement with two 280MW CCGTs in 2020, with an expected investment of above $1 billion, the project might add as much as $0.05-to-$0.08 towards DUK’s EPS. Besides these acquisitions and constructions, there are a number of commercial wind and solar power projects planned by the company, which are likely to come in operation by the end of the year. In total, the company’s growth investments is expected to be $20 billion through 2019 and offer the base for strong earnings growth in the years ahead. Furthermore, DUK’s international business, which has been facing some challenges lately have stabilized in 2015. Given the fact that analysts are expecting lower market power crisis and higher energy demand from key international markets like Brazil, amid positive changes expected in the weather, I think the company’s international business will witness modest growth in 2016 and beyond. Furthermore, DUK has an attractive capital return plan, which is largely supported by its strong cash flows. The company has paid dividends for 89 consecutive years. Talking about DUK’s future dividend payments plans at the 3Q 2015 earnings conference call, its CEO said : We have made significant progress in advancing our strategic growth initiatives, both in our regulated and commercial businesses providing strong support for our long-term earnings growth objective. Our objective is to grow dividend annually at a rate consistent with our long-term’s earnings growth objectives. In the near term, our payout ratio will trend slightly above 70%. The company currently offers an attractive dividend yield of 4.85% . Moving ahead, as DUK’s strong growth prospect initiatives will positively affect its cash flows, I expect to see uninterrupted dividend payments for shareholders, which I believe will bode well for the stock valuation, as investor confidence will increase. Summation The company is taking the correct strategic growth measures to ensure secure and sustainable earnings and cash flow growth. DUK has won the ability to apply for strong rate cases in future due to its high growth investments to get an extended portfolio of regulated renewable energy generation asset base, which will have positive impact on its future financial performance and on the stock valuation. Given the accelerated growth investments, the long-term prospect of DUK seems bright. Also, the company’s risk profile will improve given its measures to strengthen its regulated business. Therefore, I think DUK is an attractive investment prospect for income-hunting investors.

Expectations Regarding Natural Gas Prices Should Be Handled With Care – Part 2: EQT Corporation

Summary Even though the expectations regarding the natural gas prices have become even more bearish recently, I continue viewing the current situation in the markets as an overreaction. Despite the positive expectations for deep Utica play and positive analyst ratings, EQT is a risky stock with a substantial downside potential in the worst-case scenario. The company is overvalued. It is struggling to generate cash while at the same time having an accumulating debt pile. The far-away outcome of deep Utica play should not overshadow the importance of the company’s present performance and financial strength. While remaining bullish on natural gas for the nearest future, I continue analyzing securities with exposure to this commodity. Even though the expectations regarding the natural gas prices have become even more bearish recently, my view on the current situation in the natural gas market has not changed – I still perceive the recent developments to be an overreaction to the real fundamentals, and I remain long natural gas despite the higher risk. The company to be analyzed in this article is EQT Corporation (NYSE: EQT ). Being a Credit Suisse’s recent pick for natural gas exposure, the company is pretty popular among investors. With a market capitalization of $9 billion, this natural gas producer might prove to be a good natural gas bet for a variety of reasons. Nevertheless, the outlook is not exactly clear for EQT, as it is for every natural gas producer at current commodity price levels. At a total natural gas and NGL (Natural gas liquids) sales volume of 155,194 Mmcf, natural gas accounted for more than 99% of total company’s sales, placing it in a good position to benefit from the possibility of this commodity rising in price. Marcellus Play EQT Corporation strongly depends on its Marcellus wells, which accounted for 83% of total natural gas sales in the latest quarter, and this number has been nearly constant over the last three quarters. Known for many years, the Marcellus Shale only started causing excitement in 2002, when the estimations of its natural gas reserves started increasing, confirming its status of one of the largest natural gas shale formations in the U.S, which is spread over Ohio, West Virginia, Pennsylvania and New York. Marcellus is the main asset of EQT Corporation, with the company owning approximately 630,000 gross acres in the Marcellus play. Marcellus has been a major contributor to the company’s proved reserve growth, making it clear that the company is not running out of its reserves anytime soon. (click to enlarge) Source: Company’s Website , (2015). The number of wells spud in the Marcellus play is increasing strongly. The company is ramping up production, as the number of completed, not-in-use wells only rose modestly compared with the number of wells online during the last quarter. (click to enlarge) Source: Company’s Quarterly Reports , (2015). Despite the positive expectations for the future potential of Marcellus play, the 22% after-tax IRR for the realized price of $2.50 sets the scene for skepticism, as the future price dynamics of the commodity are not clear. Deep Utica Play It is well-known how the bold, full-of-hope statements make it sometimes nearly irresistible for people to turn too optimistic on a company’s potential. The willingness to have a quick profit (arguably, the most vulnerable state of a man) resulted in a possible overestimation of the future prospects of Deep Utica Play, which is currently the main focus of the company and the media following it. Seeking lower production costs, the company turned its focus to the Utica shale, which is located just below the Marcellus. I will not go in too much detail here, but I would like to outline the complexity of production in the Utica Play. At the depth of approximately 13,000 feet, with only 1 well online and 2 in progress, there is a possibility of the company’s estimated costs of $12.5-14 million turning out to be underestimated. Source: Geology.com , (2015). Nevertheless, the estimated 21% after-tax IRR at a realized price of $2, combined with production and efficiency at the low-end levels is certainly better than that for the Marcellus play, taking into account the difference in the realized prices. Source: Company’s Website , (2015). It is clear that the company’s decision might prove to be very profitable in the long run, with the company’s CEO, David L. Porges, stating the following: “If the deep Utica works, it is likely to be larger than the Marcellus over time […] we’re going to be able to supply a big portion of North America’s natural gas needs from a relatively small geography.” At the same time, it is not clear whether the best-case-scenario will unfold, as it is strongly expected at the moment. “There have been fewer than 10 wells drilled and completed in the deep Utica around our acreage, so it is still too early to say that the play will be economic,” the CEO said during the earnings call in October. Even though it is not the time to turn entirely pessimistic on the company, the downside potential for the case of the company missing the Deep Utica Play expectations should be taken into the account. Good performance of Marcellus Play, combined with rising hopes for Utica have significantly contributed to the analyst ratings, with the shares of the company currently holding 10 ” Strong Buy” and 3 “Hold” ratings . With institutional ownership accounting for 85% , should the expectations be missed, the downside risk for the stock could be substantial. Even though the number of positions initiated is currently outperforming that of the closed ones, it is important to remember the downward trend the shares of the company have been following since the middle of 2014, when the price was nearly double what it is today. (click to enlarge) Hedging Activities It is important to mention the company’s hedging activities against the further natural gas price declines. In its latest quarterly report, the company emphasized the importance of its derivative transactions, role of which I expect to continue rising over the next quarters. Source: Company’s Quarterly Reports , (2015). Even though the total cash provided by derivatives does not seem to have risen too much over the last three quarters, cash-settled derivatives accounted for 14%, 37% and 24% of the total realized natural gas price during the last three quarters, with hedging-designated ones providing more than $65 million last quarter, which is impressive taking into account that quarter’s profit of $40.79 million. So far, it is hard to deny the management’s ability to hedge the risks of environment the company is currently operating in. Even though natural gas prices have a significant potential to rise in the near future, natural gas companies’ hedging operations should be paid more attention to, as long-term plans (such as the Deep Utica Play) might become irrelevant if they either do not play out or the company runs out of its cash resources. With only 1 Utica well online at the moment, the target cost of $12.5-14 million per well accounts for only 1% of the company’s total cash position at the end of the latest quarter. Nevertheless, Deep Utica might turn out to be a severe cash burning process in case the company struggles to earn money at the current price levels or its strategy turns out to be somewhat too optimistic. The company’s current hedging position for the rest of 2015 (outlined in yellow) is sufficient enough to cover almost half the amount of the company’s natural gas sales for the latest quarter. Nevertheless, it is hard to form solid expectations regarding the hedging effectiveness in the next quarter as we cannot predict the revenue growth and the adjustments to the hedging position throughout the quarter. Despite the fact that the accumulation of the company’s hedging position for 2016 is fast-paced, average fixed prices for 2015 and 2016 are declining significantly. (click to enlarge) Company’s hedging position at the end of each quarter, 2015. Source: Company’s Quarterly Reports , (2015). Fundamentals The falling natural gas prices have had a substantial impact on the financial positions of all producers, and EQT Corporation is no exception. Despite the company’s efforts to save the revenue growth, net profits have significantly decreased during 2015, with some hope emerging for the upcoming quarters. With natural gas outlook being unclear and much time required for Utica Play to start firing on all cylinders, even more attention should be paid to the company’s current hedging activities. COGS increased strongly in the latest quarter, making the gross profit margin fall to 77.5%, way below the 2-year average of 82.4%. Revenue, Gross and Operating of EQT Corporation, quarterly, Sep 2013-2015. Source: GuruFocus , (2015). Net income margins have become quite volatile lately, falling sharply in the latest quarters and keeping return on assets and equity ratios at close range. Net Margins, ROA and ROE ratios of EQT, Sep 2013-2015. Source: GuruFocus , (2015). Following the fluctuations of the company’s revenues, interest coverage ratio has shown concerning performance during the last five quarters, falling below 1 in June 2015. Even though interest expense has been nearly unchanged at approximately $37 million over the same time period, fluctuating EBIT might become a problem in the future. There is a fast-paced accumulation of deferred tax liabilities, which have been growing by 1.82% on average during the last five quarters, conquering almost 22% of the liability part of the balance sheet by September 2015. (click to enlarge) Interest Coverage Ratio (right axis), EBIT and Interest Expenses (in $ mln, left axis) of EQT, Sep 2014-2015. Source: Morningstar , (2015). Even though the debt/equity ratio of EQT Corporation has been decreasing lately and is fairly low at 0.64, it is important to remember that the large “E” in the D/E ratio is mostly there because of a large amount of fixed assets, leaving the current ones a lot of room for improvement. The company’s cash position has been increasing strongly over the last two years. Accounting for only 12.1% of total assets, it is not sufficient to cover the long-term debt of the company, however, and the accumulating current portion of long-term debt should be paid more attention to. Company’s free cash flow has been negative since 2007. (click to enlarge) Source: Gurufocus , (2015). Although the growing debt, worsening profitability and a low Altman’s Z-value of 1.36 are concerning factors, the debt maturity schedule demonstrates why it is too early to get too pessimistic about the company’s financial position. It should be understood, however, that the company might significantly decrease its cash position in the coming future if no net profit surprises follow. Source: Company’s Website , (2015). The argument in favor of a decrease in the company’s cash position sounds even more valid when the historical net changes in cash are taken into account. Net change in cash has been negative during 3 out of the 7 latest quarters. Among the remaining 4, positive net change in cash in 3 quarters can be attributed to large stock or debt issuance (it is easier to follow with the help of the table below). Debt is slowly becoming a problem for the company, while continuous stock issuance can drive the share price even lower. (click to enlarge) Net change in cash; net debt and stock issuance of EQT Corporation, March 2014 – September 2015. Source: Gurufocus , (2015). There is a certain amount of divergence between the stock’s valuation and current performance of the company. Even though it can be said that at a price/book of 1.69 (which is close to its 10-year low) the stock seems to be fairly valued, I am returning to my argument of over-optimistic expectations due to the trailing P/E ratio exceeding 42. Conclusion Despite the positive expectations for the future of Deep Utica play, the company is heading towards additional risk. The financial strength of the company is slowly decreasing, making it strongly dependent on the outcome it will face regarding the Utica play. Even though the strategy might prove to be a major success, there is a high probability of earnings disappointments and further balance sheet deterioration in the future. Accompanied by high valuation and negative free cash flow, growing debt and cash generation issues might leave the stock with a large downside risk should the natural gas prices continue their downward trend in the nearest future. High ratings among the analysts covering the stock make it vulnerable to potential downgrades, as the popularity of the stock might turn against it. Nevertheless, there are various possible reasons for the stock to outperform as well. Positive developments in the Utica play, possibility of a dividend increase (which, despite being a questionable decision, might be introduced by the company as a save-the-day solution against the falling stock price) and the overall bullish attitude towards the company might make it a market’s darling should the natural gas prices rise as I expect them to be, although the downside risk makes it a much riskier bet when compared with Gulfport Energy Corporation (NASDAQ: GPOR ), which I analyzed in my previous article. The far-away outcome of deep Utica play should not overshadow the importance of the company’s present performance and financial strength.