Tag Archives: utilities

Con Ed Catalysts Can’t Overcome Structural Burden

Con Ed is the 6th largest producer of solar power and aggressively moving into the solar + storage markets. Con Ed has little exposure to traditional solar “losers”. 90% of earnings are derived from its regulated activates and will be the major driver of future performance. Free cash flow has a 7-yr average of +$475 million a yr, demonstrating conservative cash management. ED offers stability of earnings and dividends, but not much growth. Founded in 1880, Consolidated Edison (NYSE: ED ) is one of the original electric utilities in the US. Serving New York City and surrounding areas, ED offers a stable outlook and adequate dividend yield, just not very exciting future growth prospects. With over 90% of its earnings derived from regulated activities, ED can be considered a more “pure” utility than others of its size. Con Ed operates electric, natural gas, and steam networks servicing about 4.9 million customers, 3.6 million electric and 1.2 million natural gas. In addition, ED invests in transmission projects and solar power generating systems. ED is the 6th largest generator of solar power in the US. At the end of 2014, Con Edison Development had a total 446 MW of solar and wind generation in operation. The company is in development stage of a combined residential solar and storage pilot project. As of June 2015, Consolidated Edison Company of New York, Inc. CECONY represented 95% of combined EBITDA, and ED’s stock performance is tied to the performance of CECONY. Investors should be aware CECONY is under a base rate freeze through the end of 2016. Fitch offers a great recap of allowed return on equity and rate case issues in their Oct 2015 review: Relatively Restrictive Regulation: Authorized returns on equity ROEs continue to be below national average, and an increasing use of regulatory deferrals and rate freezes to limit pressure on customer retail rates has somewhat constrained Fitch’s view of New York regulation. That being said, CECONY and Orange and Rockland ORU enjoy several mechanisms that Fitch considers to be supportive of credit quality including forward-looking test years, multi-year rate plans, trackers for large operating expenses, and a revenue decoupling mechanism that isolates net margins from variations in retail sales. Those mechanisms do support the utilities’ long-term financial stability. Base Rate Freeze Manageable: The 2015 rate order that extended a base rate freeze at CECONY one additional year through 2016 will pressure credit metrics over the next two years but some mitigating factors lessen the adverse effect on operating cash flows and help keep the utility in line with the existing rating level, albeit at the lower range of the ‘BBB+’ rating category. CECONY will be allowed to continue the use of a revenue decoupling mechanism and trackers that provide recovery of fuel, pension and property tax expenses, and storm costs, including collection from customers on an annual basis of $107 million related to Superstorm Sandy. The rate order reflected an authorized ROE of 9%, which is significantly below the national average and below the 9.2% ROE authorized in CECONY’s previous rate order. However, the 9% authorized ROE is consistent with those received by utility peers ORU and Central Hudson Gas & Electric in their recently settled rate cases. Pending Rate Case Filing: Management has announced publicly that it intends to file a rate case in the first quarter of 2016 for new rates that would become effective in early 2017. Given the prolonged rate freeze, CECONY’s rate request to recover spent capex could be sizeable, and as a result, lead to heightened regulatory risk. Under Fitch’s rating case scenario that assumes CECONY operating under a 9% ROE over 2017-2019, the utility’s credit ratios modestly improve from weaker 2015-2016 levels. Fitch’s rating case also assumes that CECONY can continue to effectively control O&M to support the financial profile. ED has very little power generation and is mainly a distribution company. The majority of generation is wind and solar with a combined total of 446 MW, about equal to a medium-size natural gas combined cycle plant. The company is test driving a solar + storage platform for better utilization of its residential solar customers. In July, ED announced a demonstration project to develop a combined residential solar and storage program to better control the availability of intermittent power. The goal is to generate 1.8 MW of capacity and aggregated energy of 4 MWh. While small in comparison with the total needs of its customer base, this could be a footprint for further development not only in NYC but elsewhere. A good description of the solar + storage project is offered in an article on capitalnewyork.com: The final, and perhaps most sci-fi of the projects, is called the Clean Virtual Power Plant , which envisions a constellation of homes equipped with solar and storage, essentially large batteries. The homes would be wired together so they could act both as source of power for individual homes or be conducted by the utility like a symphony, with power dispatched to wherever it is needed on the grid or even sold into the state’s energy marketplace. The marriage of storage and solar is a crucial element for renewable energy as it allows power from the sun to accrue for use when it is cloudy or when it is dark. Con Ed writes that its peak load usually comes after 5 p.m. The connection of multiple homes as one “plant” hews closely to a central idea of the R.E.V. in that it upends the traditional flow of power from a fossil-fuel plant through a transmission line to customers and instead manages energy traveling in multiple directions. “The project is designed to demonstrate how aggregated fleets of solar plus storage assets in hundreds of homes can collectively provide network benefits to the grid [and] resiliency services to customers,” the utility wrote. It is interesting Con Ed could be on the forefront of developing residential solar + storage networks, and has little exposure to the potential “losers” of power plants and transmission assets. The solar + storage network could potentially flow into micro grids currently being reviewed by the Department of Defense for several installations. In 2013, I penned an article for SA titled, Micro Grids Don’t Have To Be the Death Knell for Electric Utilities , and Con Ed could become an prime example of a regulated utility moving in this direction. While Con Ed’s exposure to the solar + storage and micro grid potential could be intriguing, I don’t think it will be sufficient to offset some of its structural problems with being 95% controlled by the fate of CECONY. These include the current rate freeze and its low allowed return on equity. The New York Public Service Commission has historically been tough on Con Ed’s rate structure. The current 9.0% allowed return on equity is lower than the recent national average award of 9.5% to 9.8%. Below is a graphic from the company’s investor presentation of PSC rate decisions since 2006, and the downward trend should be obvious. (click to enlarge) With one of the highest cost of living areas in the world, Con Ed is under constant pressure to keep utility costs low for residents and commercial customers. Real estate tax increases have historically been automatically included in rates decisions. However, as real estate taxes become more of a burden in the NYC area, there is movements within the community to remove its automatic inclusion. In 2014, Con Ed paid about $1.4 billion in real estate taxes, and $1.8 billion in total taxes other than income taxes. This represents 19.7% of total operating expenses and 27% of all non-fuel related operating expenses. In addition, a fatal gas explosion in Manhattan in 2014 and another one in this past March have led to added scrutiny of the utility from regulators. It is estimated legal issues and fines could total upwards of $1 billion. Con Ed and NYC have been pointing fingers at each other over who’s to blame, but Con Ed was just officially condemned by the New York Public Service Commission for the loss of life and property. The unflattering headlines will have a negative effect on the relationship between ED and state regulators, and the final resolution will take years of court proceedings. The state regulators have established reliability performance standards for every electric utility in the state, and levies a fine for non-performance. According to consulting firm Brattle, Con Ed could be exposed to a maximum of 0.90% reduction in its allowed ROE from its performance evaluations. So far, Con Ed has been levied only minor fines for non-performance, however, as of 2012, performance issues are included in future rate decisions, keeping the pressure on Con Ed to control costs while increasing reliability to its customers. ED current stock valuation could be considered as fairly valued based on its history. Below is the fast graph of the previous 20 years. (click to enlarge) Con Ed’s return on invested ROIC has been falling recently, but has hovered around the 6.0% mark, with is better than the industry average of 4% to 5%. According to ThatsWACC.com, ED’s weighted cost of capital WACC is 3.8%, making ED’s hurdle rate around 1.4% to 2.0%, and is better than many peers who do not generate ROIC in excess of its WACC. Below is a 20-yr history of ROIC, also from fastgraph.com. (click to enlarge) Dividend increases have been small, with a 5-yr growth rate of 1.3%, a 3-yr growth rate of 1.6% and a 1-yr growth rate of 2.4%. These numbers would hardly move the needle for dividend growth investors. On the plus side, ED has raised its dividend every year since 1974 and its payout ratio is a comfortable 73%. Since Jan. 2009, management has generated positive free cash flow demonstrating a conservative cash approach. During this 7-year timeframe, ED generated in excess of $3.2 billion in free cash, very admirable in a capital intensive industry. On a trailing twelve month basis, ED’s free cash flow was $471 million. Driving earnings higher will be Con Edison’s multi-year capital expenditure budget. The company plans on spending $13.9 billion capital in 2015-19, and should increase its 2014 regulated asset base of $24.0 billion. Compared to many of its top peers, Con Ed has offered below average total return performance. Below is a 10-yr total return chart from morningstar.com for ED and four of its peers, demonstrating this underperformance of a $10,000 investment. (click to enlarge) While ED has an interesting exposure to solar power, storage networks, and the potential of moving into the micro grid markets, investors should look elsewhere for either higher yield or higher growth – or both. Author’s Note: Please review disclosure in Author’s profile.

High Dividend ETFs Should Be A Cornerstone Of Your Portfolio

Summary Dividend income is a great way to increase cash flow while not having to liquidate positions and taking money out of the market. Historically, dividend-paying companies have outperformed non-dividend-paying companies thus this strategy may boost overall portfolio return. Companies that make up dividend-paying ETFs can vary from traditional broad market ETFs, so splitting your portfolio up can help diversify your holdings. For a majority of investors, regular “stock picking” is not of interest to them. The shear amount of work and patience involved in the process tends to push the masses towards passive management, where the debate between mutual funds and ETFs begins. Without a doubt, there has been a lot of movement into ETFs due to their lower-fee structure as well as their overall net-of-fees performance compared to mutual funds. Over the past few months, I’ve begun to do a deeper dive on the value of high dividend yield ETFs to see if they are truly worth the hype. Many of the most successful investors preach the importance of investing in companies that pay steady dividends. It’s easy to understand the appeal of such companies; the ability to return cash to shareholders shows that the company is, usually, being managed well and investors can generally expect a stream of cash to supplement any unrealized gains in their shares. I’m of the personal opinion that, to some degree, companies pay dividends to keep shareholders from selling their shares. In other words, giving investors a bit of cash to pad their pockets may deviate them from selling their position when they are in need of cash – something that tends to occur increasingly during economic downturns. Of course, these dividends come at the cost of less capital appreciation, but many investors like the little bonus they see in their investment account. If you are someone who believes you should just spend the interest, not the principal, then high-dividend ETFs should peak your interest. In addition, corporations have been distributing record amounts of dividends back to shareholders recently, showcasing a need for investors to broaden their exposure. Concept of High-Dividend ETFs As the name implies, these types of funds typically offer higher payout yields compared to the average ETF. They tend to come in all shapes and sizes, so it’s important to understand that many of these funds are outside of your investment objectives. For example, most individual investors would not have the risk tolerance for the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (NYSEARCA: MORL ), which has a current dividend yield of over 30% and is considered one of the highest yielding ETFs out there unless they were looking for specific exposure the real estate market. There are, however, some more general high-yield ETFs that are of interest to someone looking to mix up their investments which maintaining their overall asset allocation. For example, someone may want to have 50% of their funds invested in U.S. Equities. Instead of having that portion of your portfolio in something like the PowerShares QQQ Trust ETF (NASDAQ: QQQ ), you could split up your U.S. Equity exposure and invest some of that money in a higher yielding ETF like the Global X Super Dividend U.S. ETF (NYSEARCA: DIV ). Of course, the industry makeup of these two funds are vastly different – QQQ is highly focused in the technology sector while DIV has more exposure to Utilities and Real Estate, but this could actually prove to help with overall diversification for your investment in a particular economy like U.S. Equities. One of the reasons I have tried to increase my exposure to dividend-paying stocks and ETFs is because, according to a study by BlackRock, they have outperformed non-dividend paying companies over the long-term. As you will see below, this is the case both in bull markets and bear markets. Risks One negative view has surfaced regarding dividend ETFs recently. An article on Bloomberg showcased that for the first time ever, dividend ETFs are projected to have an outflow of capital for the year. Although there are many reasons for this phenomenon, including investors choosing to change their investment mix to other markets that may not be as much dividend-paying as growth-oriented, it is a trend that needs to be watched to ensure there isn’t significant downward pressure on the actual price of these ETFs. As always, it is important when using ETFs in your portfolio to review and understand the underlying investments (i.e. companies) that are held in the portfolio. As long as dividend-paying companies continue to perform well and corporations continue to pay and grow their dividend, there shouldn’t be any significant risk to these funds. Portfolio Strategy For an investor looking to produce some extra income, and potentially even diversify their portfolio more, high-yielding ETFs are a great product to help you achieve this goal. What I would recommend, especially at the beginning, would be to structure your portfolio in a way that only half of a given asset allocation is invested in a high-yield ETF to begin with. Similar concept to my example above, let’s say you currently have a portfolio of 30% Fixed Income, 40% U.S. Equities, and 30% International Equities. I would recommend keeping 15% of your Fixed Income investments the same and the other 15% I would find a high-yield bond ETF to keep the same exposure to fixed income, but with more income; keep in mind that, especially true with fixed income, higher yield is typically higher risk investments. Similarly, I would take 20% of your U.S. Equity allocation and invest in a high-yield U.S. Equity ETF, like DIV I mentioned above. Finally, I would take 15% of the funds I have in International Equities and find a similar type of non-North American ETF that offers a high-yield. One such example would be the FlexShares International Quality Dividend Index ETF (NYSEARCA: IQDF ). Something like the Arrow Dow Jones Global Yield ETF (NYSEARCA: GYLD ) may work as well, keeping in mind that as a “Global” ETF it would still have exposure to the U.S. market so you need to be careful to ensure your overall portfolio allocations are still intact. As always, if this type of investment is of interest to you I highly recommend speaking to a licensed financial professional to see which funds match your overall risk and return objectives.

Consider Midwest Utility ITC Holdings For Your DGI Portfolio

Summary Following my analysis of Wisconsin Energy, Southern Company and Avista, I decided to look at another possible growth prospect in the utilities sector. ITC offer superb growth opportunities together with great fundamentals and fair valuation. However, there are still several risk factors that must be taken into consideration, especially when we know it is a utility company. If you follow my last two articles, you will see that lately I am writing and debating with the readers about utility companies. I also wrote two articles about utilities back in March. The debate is whether one should look for a classic utility with high yield and low growth such as Southern Company (NYSE: SO ) or medium yield and medium growth like Wisconsin Energy (NYSE: WEC ). I must also note that I invest in Avista (NYSE: AVA ) as well, which also has medium yield and growth. I mentioned two out of the three types of dividend growth stocks. The third one is low yield and high growth. ITC Holdings (NYSE: ITC ) is a great example of such a company. I am going to analyze this company in this article, as I try to look for new investment opportunities. I found this stock while doing one of my routine screening, and I found out that it isn’t well known among dividend growth investors. ITC Holdings is a holding company. Through its regulated operating subsidiaries, International Transmission Company, Michigan Electric Transmission Company, ITC Midwest LLC and ITC Great Plains. It is engaged in the transmission of electricity in the U.S. It operates high-voltage systems in Michigan Lower Peninsula and portions of Iowa, Minnesota, Illinois, Missouri and Kansas that transmit electricity from generating stations to local distribution facilities connected to its systems. Fundamentals The fundamentals shown by ITC are really remarkable. They are remarkable for any company, and especially for a utility company. The revenue rose steadily over the past decade. Ten years passed since the initial IPO of the company, and in these ten years the revenue grew from $200 million in 2005 to $1020 million in 2014. This is CAGR of 17.69%. This rate will not be sustained, but the revenue will keep growing in the next years to come at high single digits according to the management. ITC Revenue (Annual) data by YCharts EPS also grew in a very impressive manner, and it is going to grow quickly in the next years to come. Issuance of new shares slowed the EPS growth, but as you will see, it had very little effect. The EPS grew from $0.353 in 2005 to $1.54 in 2014. This is CAGR of 15.87%. This is again an amazing number especially for a utility. The company is forecasted to show EPS of over $2 in 2015. The company reiterates its five year plan, and is going to show double digits EPS growth until 2018. ITC EPS Diluted (Annual) data by YCharts The dividend also grew quickly over that decade. It grew at a slower pace than the EPS, so the payout ratio actually declined to around 36%. In addition, the company told investors in November that it might expand the payout up to 40% in the future. The dividend grew from $0.175 in 2005 to $0.61 in 2014. This is CAGR of 13.3% which is great. In 2015 the dividend was raised by additional 15%, and the management is willing to raise the annual payment by 10%-15% annually. The drawback is that the current yield is very low for a utility company at just 2.2%. ITC Dividend data by YCharts Over the past decade the amount of shares outstanding increased by around 50%. This is typical for companies that are growing, issuing equity is a common way to raise capital. However, in the last two years, 2014 and 2015, the board authorized a buyback plan of $250 million. The board is positive about the strength of the balance sheet and the cash from operations, and I believe it will issue another similar plan in 2016. $250 million is around 5% of the shares outstanding, pretty impressive. Valuation ITC is really fairly valued. The forward P/E is around 16. When taking into consideration the double digits growth rate, some might say that the valuation is low. The high growth rate is lowering the P/E for 2016 and 2017 significantly. If I have to determine, I find it valued fairly to slightly undervalued. ITC PE Ratio (NYSE: TTM ) data by YCharts The reasons for the lower valuation are the fact that ITC is a less known company with no buzz at all, and the fact that the dividend yield is extremely low for a utility company. If the company can achieve its dividend growth goals, it will be a great opportunity for long term investors. Opportunities ITC enjoys a high rate of revenue, EPS and dividend growth. This growth is achieved while the company is practically a monopoly in several states, as it possesses a very wide moat due to its massive infrastructure. If the company can grow that quickly while being a supervised monopoly, it has a pretty bright future. ITC will also enjoy the transformation on the American energy market. As power plants using coal are closed, and plants using naturals gas and renewable energy are opened, they will all need to transmit the electricity from the plants to their customers. The massive infrastructure owned by ITC will be ready to join forces with the power plants. In my previous article about Southern Company and Wisconsin Energy, I was told by several readers, that SO has an advantage over WEC, and it is the fact that it operates in the growing south and not in the Rust Belt. I am not sure that this is an advantage for the long term, as the economy is cyclical, but ITC for sure has nothing to worry about it. The company is well diversified, and it operates and in the Rust Belt as well as in the south. Geographical diversification is always a plus for a utility company which is usually locked in a certain area. Another advantage is the regulation. While the typical utility company is regulated by the states and the federal government, and therefore in a position where it can suffer from multiple state jurisdiction, ITC is solely regulated by the federal government, because it is an electric transmission company. In addition, the allowed return on equity is higher, which allows the company to charge more money for its service. According to S&P, the allowed ROE by the federal government is between 12.16%- 13.88%. Risks The first risk is competition. The competition can come from two places, other transmission companies especially from the west, and electric companies that can build their own infrastructure. The advantage of ITC is the fact that infrastructure requires a lot of capital. This is the wide moat that the company has, and the reason for this risk to be less relevant at current prices. The federal regulator received in 2013, a complaint asking for the reduction of the allowed ROE. A similar case in New England back in 2011 resulted in reduction of the allowed ROE two years later. This might harm the profitability. However, the request wasn’t fully granted, and I believe that the same will happen here as well. The low dividend is another downside. Yes, it can and should grow in the near future. The company believes that it can sustain substantial growth for the long run here. However, the profits depend on the regulators, and a change in the regulation might slow down the dividend growth, and we will have a utility stock that yields less than 2.5%, not something to brag about. The debt load is high, and is getting even higher. With the interest rates raising, it will be even more expensive. The company is using at the moment debt to finance its operation. The expects annual cash from operations to be around $650 million, while the annual capital investment is $800 million. Now, add the dividend and the buyback, and this small company must have access to credit at all time. The management is aware of that, and they know that their goal is to maintain the current credit rating- A. Conclusion Well, I can’t see myself buy ITC now, I prefer WEC and AVA over it. The growth is important and unique for a utility, but it will take years for it to reach a “utility yield”. It will need 5 years of superb growth to reach the yield of WEC, and 8 years of superb growth to reach the yield of SO. My preferred utility companies are the medium growth and medium yield like WEC and AVA. Therefore, I prefer these two over both SO and ITC. If you have several utilities and a very long investment horizon, you should consider adding ITC to your dividend growth portfolio. If you are a value investor, you might be buying it as well, as the growth prospects are here and valuation is fair. You can initiate a small position and enjoy the growth, it is an odd utility by yield and payout ratios as well as by growth, but it is also a great company, that isn’t necessarily right for my portfolio.