Tag Archives: utilities

American States Water Company: A Helping Hand Boosting Growth

American States Water Company’s shares have become undervalued as a result of negative earnings results in the past. This undervaluation does not take into account the favorable Californian regulatory environment that could help move the company along. Investors looking for a stable, long-term investment opportunity with the potential for capital appreciation should consider picking up the company’s shares. As investors know, utilities companies are some of the most stable companies that investors can invest in. These companies are known for their strong, stable balance sheets that regularly doll out steady income in the form of dividends. Not many investors would consider utilities companies as investments for risk-loving investors, given the fact that demand in the utilities industry is so inelastic. This inelasticity stems from the fact that consumers will purchase utilities services no matter what happens to the general economy; after all, no one in their right mind would save money by cutting off their water or heat. But small cap utilities companies can offer investors looking for something else a chance at both capital appreciation and steady income. Given the nature of small cap companies, small cap utilities companies give investors the chance to outperform the general market without too much risk involved. This is not to say that company-specific risk can still play a role in increasing the overall risk in a portfolio, but industry-wise, the risk in that aspect is rather low. One small cap utilities company that investors should consider taking a look into is American States Water Company, Inc. (NYSE: AWR ), a pure play water company that mainly serves customers in California by providing water and electric utilities services. The company operates through two main businesses: Golden State Water company and American States Utility Services, and each of these business segments has their own individual subsidiaries. Golden State Water company contains Golden State Water, a regulated water utility company, and Bear Valley Electric, a regulated electric utility company. Furthermore, American States Utility Services contains a number of subsidiaries, including: Fort Bliss Water Services company, Old Dominion Utility Services, Old North Utility Services, Palmetto State Utility Services, and Terrapin Utility Services. All of these subsidiaries enable a strong amount of diversification within the company’s sales mix, which enable investors to share in that diversification indirectly through an investment in the company’s shares. Moving on to the company’s stock chart, investors can see the outstanding returns that the company has generated for investors. Funds invested in the company on the onset of calendar year 2011 would have generated a return on investment of more than 150%, not bad for a utilities company. While the company has had a great turn in the years 2011 throughout 2014, the company’s shares recently began slowing down in value growth. That, in part, is due to macroeconomic events out of the company’s control, and thus, investors should not discount the stock due to a slowdown in value growth throughout 2015. In regards to a technical perspective, the 50-day moving average has been basically above the 200-day moving average for the most part, with the 50-day moving average occasionally touching the 200-day moving average. The two technical indicators’ spread have been widening recently, which could signal near-term upside. (click to enlarge) Source: Stockcharts.com From a fundamental standpoint, long-term investors have much to feast upon. The California water utilities regulation has been particularly favorable in the sense that regulators are taking action to make processes more streamlined and adjust the way that water usage is measured. Through this favorable regulatory environment, the company can once again augment its customer expansion and increase top-line growth. As a result of numerous earnings calls in the past that yielded negative earnings growth, investors have discounted the stocks’ investment potential, but these investors fail to see the long-term picture. As such, shares of the company have become undervalued and are ripe for pick up by value investors with that long-term perspective in mind. Growth in EPS has been unsteady, but that could change with this favorable regulatory environment as the company streamlines its operations and widens its margins, boosting EPS. While the utilities industry is indeed a heavily regulated industry, and while industries that are heavily regulated are subject to the whims of the government, in this case, that’s a good thing. The company will have a helping hand prop up and reignite its growth engines. Investors looking for a stable, long-term investment that has the potential for capital appreciation should consider investing in American States Water Company.

Enersis’ (ENI) Q3 2015 Results – Earnings Call Transcript

Enersis S.A. (NYSE: ENI ) Q3 2015 Earnings Conference Call November 03, 2015 10:00 AM ET Executives Javier Galan – Chief Financial Officer Analysts Cosma Panzacchi – Bernstein Research Javier Suarez – Mediobanca Antra Murra – Santander Nicolas Schild – Santander Carmen Concha – Moneda Ezequiel Fernandez – Scotiabank Operator Good day, ladies and gentlemen, and welcome to the nine month results 2015 Enersis Earnings Conference Call. My name is Sonia, and I will be your operator for today. During this conference call, we may make statements that constitute forward-looking statements within the meaning of the private securities litigation reform act of 1995. These statements could include statements regarding the intent, belief, or current expectations of Enersis and its management with respect to, among other things, Enersis’ business plans, Enersis’ cost reduction plans, trends affecting Enersis’ financial condition, or result of operations, including market trends, electricity sector in Chile or elsewhere, supervision and regulation of the electricity sector in Chile or elsewhere, and the future effects of any changes in the laws and regulations applicable to Enersis or its affiliations. Such forward-looking statements reflect only our current expectations and not guarantees of future performance, and involve risks and uncertainties. Actual results may differ materially from those anticipated in the forward-looking statements as a result of various factors. These factors include a decline in the equity and capital markets of the United States or Chile, an increase in the market rate of interest in the United States or elsewhere, adverse decisions by government regulators in Chile or elsewhere, and other factors described in Enersis’ Annual Report on Form 20-F included under Risk Factors. You may access our 20-F on the SEC’s website, www.sec.gov. Readers are cautioned not to place undue reliance on those forward-looking statements, which speak only as of their date. Enersis undertakes no obligation to update these forward-looking statements or to disclose any deployment as a result of which these forward-looking statements become inaccurate. I would now like to turn our presentation over to Javier Galan, Enersis’ CFO. Please proceed. Javier Galan Good morning, and welcome to our nine months conference call results presentation. I am Javier Galan, CFO of the Company, and with me today is Pedro Canamero, our Investors Relation Director. Please, let me remind you that the presentation will follow the slides that have been already uploaded in our website. Also, as always, we will have the usual question-and-answer session at the end of this presentation. First, on slide number two, I will start by outlining the main updates of the period. During the first nine months of the year, EBITDA recorded $2.6 billion, increasing by 8% compared with the same period of last year. This was mainly due to the positive performance during the third quarter in generation business in Chile and the positive results in distribution business in Argentina due to resolution number 32. This was partially offset by a negative exchange rate effect in Brazil and Colombia. Net income attributable to Enersis shareholders increased by 49%, reaching $653 million due to an adequate operational performance and better financial results compared to the same period of last year. As a result of this, earnings per share for the first nine months of the year was CLP8.3 per share compared to CLP5.5 last year. In October 6, our Colombian generation subsidiary, Emquesa, announced the initial generation tests for the 400 megawatt new hydro plant, El Quimbo. It is expected to enter into a commercial mode for mid-November. Let me just remind you that the energy production of this investment on a yearly basis should be approximately 2.2 terawatt hours, with an implied load factor of 63%. Finally, I would like to highlight the outlook improvement in Chile due to range rated El Nino phenomenon. During September, our hydro capacity increased by 17% versus the previous month. Year-to-date, the total hydro capacity of our plant in Chile grew by 20%. Let me now focus your attention on the macro scenario for this year in slide number three. Despite the global macro trends related to commodities, US dollar interest rate expectations and currencies, GDP growth of the countries where we operate, with the exception of Brazil, continue to increase at more than 2% annually. This is reflected in our electricity demand growth evolution of the first nine months of the year compared with 2014. On this respect] let me highlight the resilience of countries like Colombia and Peru, which shows a demand growth that continued to stay at the same level, or even higher compared with last year. This compensate the lower activity in Chile and Brazil being Ampla, our distribution company in Rio de Janeiro, the most effective company due to its exposure to a lower demand growth and higher electricity losses. Regarding spot prices in Chile, we’re down 44.2% compared with the same period of last year, mainly due to a rainier season that continued to show a similar trend in October. However, in Chile, we have not achieved an average hydro year yet. Let’s now take a look to our main operational highlights under the scenario on slide number four. The installed capacity of Enersis Group increased by 3.6%, or 555 megawatt due to El Quimbo hydro plant in Colombia for 400 megawatts, the restart of the gas plant TG7 in Peru for 157 megawatts, and the last unit of the Salaco Chain hydro plant for 18 million megawatts in Colombia. Net production of the Group remained flat in the first nine months of the year. Here, the lower hydro production in Brazil was partially compensated by higher thermal generation in Chile. Finally, distributed electricity increased by 2% due to higher energy sense in all the countries where we operate. On this respect, the most important areas of growth were Peru and Argentina, which increased by 4%. The number of clients at the end of September amounted to 15.1 million clients, 449,000 clients higher compared to the same period of 2014. In slide number five, let me explain the main regulatory items for the period. In Colombia, as you know, the worst tax for the full year recorded in January impacted EBITDA by $23 million. This tax will last until 2017. And regarding the new regulatory cycle, we are expecting to have the final work definition during the fourth quarter of 2015. In Peru, since September 24 and following decree law number 1,221, the recent modification to the distribution tariff calculation for the next regulatory period 2017-2021 regarding from a sector model base to a real value-added distribution base on each company. We do not expect changes in the final tariff as the current model company is very similar to us in terms of efficiencies. In Brazil, the distribution company Ampla sent a request to ANEEL asking for an extraordinary tariff review recognition based on the CVAs already accumulated during the year, an increase of uncollectables recognized in the tariff, and an improvement of the regulatory index related with [indiscernible] losses. Now, on slide six, we will analyze the financial highlights for the period. Revenues increased by 9%, and EBITDA by 8%. This is mainly explained by the 4.1 recovery of the EBITDA in the generation business, which produced $669 million in the last quarter, together with the stable distribution business, which recorded $388 million in the same period. The overall company EBITDA during the third quarter was almost $1 billion. Net income attributable to Enersis shareholders increased by 49%, recording $653 million in the first nine months of the year due to the combination of better operational results, the positive effect of additional minorities interest acquired during 2013 in [indiscernible], and GasAtacama, and a better financial result, which improved by 54% during the period, which will be explained later on. Net debt increased by $240 million mainly due to higher investments. Let me analyze the EBITDA and the net income evolution in more detail in the following slides. On a country-by-country basis, and comparing with the same period of last year, overall EBITDA increased by $181 million, or 8% despite the negative impact of translation effect rate in Brazil and Colombia. In Chile, EBITDA increased by 36%, amounting to $678 million in the first nine months of the year. During the third quarter of 2015, Chile EBITDA reached $344 million, increasing more than 30% compared to last year. This was possible due to our lower spot market prices related to a better hydrology in the country, (inaudible) generation, and the effective thermo plant energy management, which more than compensate the perimeter effect of non-corrective we saw last year in particular in Milan and Enel. In Brazil, EBITDA decreased by 22%, or $132 million as of September this year, mainly related to the exchange rate impact of 17.5%. The remaining negative impact of 4.7% is related to higher energy purchase costs, inflation, and fixed costs in Ampla. This was partially offset by the good results in Coelce, which is on the fourth regulatory cycle with an increasing demand growing at the rate of 2.4%. In Colombia, the business was also impacted by a negative exchange rate effect of 16%. Net of this effect, results were flat compared to last year. Let me remind you that this year’s results contain a wealth tax of $23 million recorded at EBITDA level during the first quarter of 2015. In Peru, the business continues to grow at a solid rate mainly due to the good performance of the distribution business showing a 15% increase in EBITDA in the first nine months of the year, reaching $166 million. This is the result of higher accumulated electricity demand, which grew at the range of 4.7%. Finally, in Argentina, the EBITDA increased by $257 million during the period, mainly due to the distribution business as a result of the already-mentioned resolution number 23. On next slide, you will find a brief overview of the EBITDA breakdown by country and by business. Colombia remains as the main EBITDA contributor, generating one-third of the accumulated EBITDA in the first nine months of the year. Together with Peru, these two countries amount for $1.3 billion of EBITDA, or 49% of the total figure, amounting $2.6 billion. Chile also increased its EBITDA contribution since last year, moving from 21% to 26% as explained in the previous slides. In terms of business activity, generation represents 58% of the consolidated EBITDA, 2% higher than last year. Let’s now have a look at the main factors determining the Group net income on slide number nine. In addition to EBITDA and EBIT growing 8% and 10% respectively during the first nine months of the year, we have had a relevant positive impact of financial results, which decreased by 54% or $260 million compared to the same period of last year, recording $223 million. This was mainly due to the following factors. On the one hand, a higher financial income of $180 million related to 2015 IFRIC 12 remuneration and CPA indexation in our Brazilian assets. Secondly, in the other hand, lower financial expenses for $105 million in part related to the exchange rate effect on lower debt in Argentina. Finally, the effective tax rate during the period was 38.5% if compared to the 41% registered in the same period of 2014. As a result of all this, total Enersis net income increased by about 32%, reaching almost $1.1 billion and net income attributable to Enersis shareholders, which determined the earning per shares and the dividend, increased by 49% to $623 million. Let me now focus your attention on the capital expenditure structure on slide number 10. During the first nine months of the year, growth investments increased 36% compared with last year, mainly due to El Quimbo, which explains 47% of this variation. Overall, net investments amounted to $1.2 billion, increasing 5% if compared to last year. 55% of this CapEx was destinated to generation activities, and 45% to distribution activities. With all these elements, let’s analyze the cash flow on the net debt evolution during the first nine months of the year in the following slides. During the first nine months of the year, funds from operations amounted to $1.6 billion after tax payments and financial expenses. This amount covered both maintaining and growth CapEx. Re-concentration of dividends distributed during the first half of the year to Enersis shareholders, including minorities, for a total amount of $110 million was the main factor explaining the negative cash flow that equaled to $674 million. We expect an actual recovery of this trend during the final part of the year. Now taking into account this free cash flow evolution, let me explain you the net debt evolution in next slides. During the first nine months of the year, net debt increased by $240 million from $3.1 billion to $3.3 billion, mainly due to the cash flow evolution already mentioned and the positive impact of our debt mainly denominated in local currency following the natural debt allocation, which tends to be in the same currency of the flows of the Company — that the Company receives. Finally, let me give you an overview of the gross debt and maturity profiles in slide number 13. As of September 2015, gross debt amounted $5 billion, 18% lower compared to December 2014 as a result of the exchange rate effects and some loans repayments. The average cost of debt remains stable at 8.4%. Total liquidity amounted to $2.9 billion, allowing us to easily service our debt through 2017. This liquidity position includes committed and uncommitted credit lines for $1.2 billion and cash and cash equivalents of $1.6 billion, of which $1.2 billion are related to capital increase. Our short-term maturities are $180 million for 2015, and $849 million for 2016. Thank you very much, and now let me hand over to the operator for the Q&A session. Please, Operator? Question-and-Answer Session Operator [Operator Instructions] Our first question comes from Cosma Panzacchi of Bernstein. Your line is now open. Cosma Panzacchi Hi, thank you for taking my call and my questions. I have three brief questions. The first one is industrial. So, I’ve seen that there has been a general increase in losses in your distribution business across several countries. Could you actually explain what is driving this trend, and what plan do you have in place to actually optimize the losses again? The second question regards the impact of El Nino, especially given your exposure to Colombia. I wonder if this will create a potential headwind, going forward, or not. And then, the third question regards guidance. If I remember correctly from the H1 call, you were positive about your possibility of achieving the end of year targets or guidance, if you want. Do you still maintain that optimistic approach, or that positive approach? And looking forward to 2016, if I remember correctly from also the numbers that Enel has shown in the past, Enersis is expected to grow the EBITDA by approximately 20% in the generation business. Do you still think that that’s achievable, given the evolution of the macro? Thank you for taking my questions. Javier Galan Thank you very much for your question. I’ll try to address on the same order that you did them. On the industrial side, yes, we have had a general increase in losses in different distribution companies. I would say the DB Ampla, the one that is being more affected during [indiscernible] due to a higher distribution — costs on distribution, and higher losses due to theft in specific areas in Brazil, and related also to the current scenario on the country. In the second question you made related to El Nino exposure, I may say that currently in Colombia, we are expecting this situation to remain mainly at the half of next year. And currently, we are in a very good, sound position on the reserves, or both El Guavio and Betania, with 19% and 17% approximately of capacity higher than the system capacity, and along with higher prices on the region, we think we are well set up on what position in this scenario. And the third question, as you know, we do not give guidance. We have had a very good third quarter, as you saw, with $1 billion generation of EBITDA, and we are optimistic on the fourth quarter relating to specifically Chile potential generation capacity. Operator Our next question comes from Javier Suarez of Mediobanca. Your line is open. Javier Suarez Hi, good afternoon, Javier, Javier Suarez of Mediobanca. Thank you for taking my questions. I have three of them. The first one is on the debt structure of the Company. In the slide number 12, you are reporting an increase in the net debt from $3.1 billion to $3.3 billion. In terms of financial in hard currencies there, so local currency, can you break down for us by the different countries which is the [indiscernible] of your financing that is in local currencies versus hard currencies, I guess, in US dollar terms? That is the first question. The second question is on your EBITDA. Can you give us an idea on the percentage of your EBITDA on which the revenues stream is effectively in US dollar, i.e. in hard currency? I’m trying to make up my mind in the matching between your revenues stream and then the service of the debt. And the third question that I have is can you guide us through why the Company is suffering a decrease on the financial expenses when the Company has [indiscernible] on increasing the net debt position by 8%, and also the average cost of debt is also slightly increasing? Many thanks. Javier Galan Okay. Related to the debt structure shown on slide number 12, I will say that, related to the structure of this debt, we finance basically the distribution businesses and companies with local currency due to the fact that we do not have any indexation to dollars or — to dollars. And in the generation, we are basically — in generation in Chile and generation in Peru, we are financed in dollar terms due to the correlation on the dollar, on the way the tariff is determined. And the others are mainly on local currency. In terms of EBITDA, as I said before, we have revenues mainly in generation in Chile and Peru related to US dollars, so that’s the amount you should try to make up in terms of how much are we saving or how much are we indexed to dollars in this regard. In reference to your last question about the financial expenses, I made an explanation of why we had this reduction of financial expenses. That is mainly due, as I said before, so compensation on IFRIC 12, both on distribution businesses in Ampla and Coelce, which will have this year a positive effect, and last year we had a negative effect. So, we are (inaudible) is a relevant amount. Also, we have some cancellation of financial expenses in Argentina related to CAMMESA debt. And yes, we have had a slight increase in costs in financial expenses, both in Colombia and Brazil, not relevant at this moment. And we also had less income related to — as we have had less cash due to the fact of the investments we made in the first half of the year, the cash related to the capital increase. So, that is the general effect on our financial expenses. Javier Suarez So, to be 100% clear, none of your distribution activities in Latin America are financed in hard currencies, and only the generation in Brazil and Peru are financed in US dollar terms, correct? Javier Galan Yes, distribution companies, that’s right. In generation, it’s Chile and Peru are financed in dollars. Javier Suarez Chile and Peru, okay. Many thanks. Operator Our next question comes from Antra Murra of Santander. Your line is open. Antra Murra Javier, thanks for taking my question. My question is about the tariff provision in Codensa. When it’s supposed to be — what’s your BOO this revision? Javier Galan See, we expect the revision to take place in the last part of the fourth quarter of this year. And as you know, there will be a reduction on the WAC. Today we have our WAC currently in 13.9%. We expect a reduction of 1%, 1.5% reduction, which is still — will be a very important remuneration for our asset base. Antra Murra Thanks. That’s it. Operator Our next question comes from Nicolas Schild of Santander. Your line is open. Nicolas Schild Hi, thank you for taking my question. You have said in the past that one of the reason for restructuring all the LatAm assets is the holding discount that is really high on Enersis, and is lower in the case of Endesa. So, that would imply, at least in my opinion, that one megawatt, for example, [indiscernible] of Enersis should be values, or should have a less — a lower value than one megawatts in the hands of Endesa. Do you think that the valuations are going to consider this when you do the transaction to calculate the terms of exchange? Javier Galan Thanks for your question. No, I think that it’s not now the moment about commenting on different valuations which are being done in the different companies which are looking at this potential reorganization. Nicolas Schild Okay, thank you. And my second question is regarding the future growth in Chile, because in July there was a — you sent a press release disclosing that you’re going to have three terawatts of product in the pipeline of Chile, of which more than two terawatt would be constructed in the next five years. However, today there is an interview to the industry and analysis in newspaper where he said that the growth is going to be on Chilectra, because the generation opportunities — or they would do it in the generation business [indiscernible] time. When do you plan to clarify this? It’s going to be before having the shareholders meeting, or where do you see the growth in the future for this company, in both business in Chile? Javier Galan Thank you for your question. I think we have a very flexible and different optionalities in our pipeline, and we still have a very wide optionality portfolio of doing and growing in Chile. And we will develop this potential pipeline depending on the demand and depending on the prices on the country. And now, I’m trying to achieve a reasonable return for our shareholders. Regarding what you said about distribution and generation, I think that this company is in distribution business, such as the one which is in Chile. I think it’s very evolved business with a very high standard of consumption. I think that what Mr. Daniel Fernandez was trying to say is that there’s an opportunity to grow in giving more value to clients in Chile, and he was not talking more about the investment plan. Nicolas Schild All right, thank you. And my last question is regarding Ampla. Can you remind us what would be the regulatory EBITDA of that operation, and why is there the big difference between them [indiscernible], or also you are, for example, increasing expenses to lower that safe, or if you can do — if you give us a breakdown or where you’re losing that difference? Unidentified Company Representative Nicholas, about the regulatory, let’s say, review of Ampla, it’s still to be seen, which is going to be the final quantity that the DML is going to be recognized. And as we said in slide number five on October 29, on October 29 we asked for this RTP that should come in the next month. So, we have to see which of these three points has been commented are going to be taken to [indiscernible] by the regulator in order to anticipate this kind of [indiscernible] to Ampla. Nicolas Schild Okay, thank you. Operator Our next question comes from Carmen Concha of Moneda. Your line is open. Carmen Concha Hi, good afternoon. Which are the companies paying management fees in Peru and in Brazil? Can you tell us a little about the services that are provided by Enel related to these charges? Javier Galan Could you repeat your question? Carmen Concha We saw that the companies paying management fees in Brazil and Peru, so we would like to know a little about the services that Enel is providing related to these charges. Javier Galan I would say that there are two companies in Brazil, and Peru have signed a general service contract agreement with Enel. This general service is a framework contract which provides potential technical services or procurement, or other support activities being provided on markets like this by Enel on a customary basis on a one-by-one — on a specific basis, no? I think that the idea is to generate this framework contract in order to be able to take advantage of this type of potential services. So far, services have not been yet paid, and they are [indiscernible] contracted on a standalone by each of the companies on this framework contract. Carmen Concha Well, in the case of Peru? Javier Galan Both cases, in Peru and in Brazil. Carmen Concha So, the management fee is paid only when the services are provided, not now? Javier Galan Yes. Carmen Concha Okay, thank you. Operator [Operator Instructions] Our next question comes from Ezequiel Fernandez of F-O-T-I-A. Ezequiel Fernandez Yes, hi, guys, thank you for taking my question. I have three questions. I’d like to go one-by-one, and sorry if I repeat myself, because I got disconnected from the call. First is regarding the CapEx levels at Codensa and Edelnor, which went up materially for historical standards during this year. Any particular project or reason behind this? Should we expect lower CapEx in both operations maybe in the next one or two years? Javier Galan Okay. I think no, we are not expecting a reduction on the CapEx in Codensa or Edelnor. We are basically investing in quality, and in higher quality connections. And we aren’t expecting lower CapEx. Ezequiel Fernandez Okay, great. And my second question is also related to Ampla. If DNL does not grant an anticipated tariff update like you recently requested, would you need to do a capital injection from Endesa Brazil into Ampla maybe in upcoming months, or do you think it’s not that serious yet? Javier Galan We are studying the situation of Ampla. And as you mentioned, we have asked this tariff review. We are expecting to know from the ANEEL when are we going to have some feedback. I think that the situation of the Company is we need to monitor the situation, and we are studying different opportunities together with the financial community right now. Ezequiel Fernandez Okay, great. And I want to ask you a question about — finally about Edelnor, the Lima distribution unit. The results have been previewed lately, and I’m not very knowledgeable about how exactly the tariff update mechanism takes place. But, I do remember something. It seems that Edelnor tariff might have a higher pass-through to the US dollar than the regular — I mean, the rest of the distribution units. Would you agree with that, or maybe that the results are — especially in profitability, on profit per megawatt hour are related to other stuff? Thank you. Javier Galan No. In Edelnor, there’s no indexation to US dollars, if that was your question. (Inaudible) that there is a new system, and instead of being a system related to a standard company’s going to be on a company basis. No, our comment was that the standard has been used. As of today is very similar to the one we currently have, so we do not expect changes on this regard. Ezequiel Fernandez Okay. Anyway, I was speaking about the profitability increase that we have seen in the last two years in Edelnor, but maybe I can take that question with Pedro and his team after the call. So, thanks a lot, very clear. Operator And I am showing no further questions at this time. I would like to turn the call back to Management for any further remarks. Javier Galan Thanks. Well, seeing as there are no more questions, I would like to thank you for your time and your attention. Remember that our Investor Relations team will be glad to assist you in any further questions you may have. Have a nice day. Thank you. Good bye. Operator Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.

Are Utility Stocks In A Bubble?

Summary Utility stocks have benefited significantly from extremely low interest rates over the last 5+ years. Yield-starved investors have chased the sector, and utilities’ high debt loads have benefited from lower financing costs. The utilities sector plunged over 3% on Friday with expectations rising for the first Federal Funds rate hike in nearly 10 years. We look at the sector’s current yield relative to history and how it performed during the last period of tightening. Utility stocks pay some of the safest dividends around and typically sport much higher dividend yields than the market, reflecting their low growth prospects and making them a favorite source of income for retirees living off dividends . Many dividend investors wonder if favorite utility stocks like Duke Energy (NYSE: DUK ), National Grid (NYSE: NGG ), NextEra (NYSE: NEE ), Dominion Resources (NYSE: D ), and Southern (NYSE: SO ) are in a bubble today after benefiting from extremely low interest rates for more than six years. Utilities were clobbered on Friday after strong employment data strengthened the likelihood that the Fed would raise interest rates next month for the first time since mid-2006. The fear is that many investors flooded into higher yielding stocks like utilities because they could not earn enough safe income from the very low yields bonds offer today (see below). Once bond yields begin to rise as the Fed gradually raises its target interest rate, these investors might sell their stocks to purchase bonds. Source: Simply Safe Dividends , Federal Reserve Bank of St. Louis As seen below, we have been living in unprecedented times over the last seven years, with the Fed’s target interest rate remaining just above zero percent. It has never been this low for this long before, so there is plenty of uncertainty regarding how an eventual interest rate increase, as early as December, will impact markets and yield-sensitive sectors like utilities. Have these safe haven sectors been artificially inflated by the Fed’s easy money policy? Will they pop when interest rates begin to rise? Source: Simply Safe Dividends, Federal Reserve Bank of St. Louis Many dividend investors are clearly worried. On Friday, November 6th, a strong US payroll report came out. The Fed watches employment figures and inflation to determine its stance on interest rates, and the strong jobs report signaled that a rate hike in December was now almost a certainty. This would be the first rate increase since 2006. Immediately, many dividend aristocrats and utilities sold off hard. The XLU utility ETF finished the day down more than 3.5% despite the S&P 500 finishing about flat. Clearly the knee-jerk interest rate trade is to sell higher yielding, slower growing companies like utilities in favor of interest rate beneficiaries like banks (the Financials sector was the strongest performer on Friday) and more cyclical growth companies that would benefit the most from an improving economy. Before diving into utilities in particular, let’s take a step back and look at the S&P 500’s dividend yield relative to its history and the Federal Funds Target Rate. As seen below, the S&P 500’s dividend yield sits just below 2% today compared to the Federal Funds Target Rate of 0.25%. If we were living in a dividend stock bubble that could be popped by rising interest rates over the next few years, we would expect the market’s dividend yield over the past several years to be extremely low relative to history. Source: Simply Safe Dividends, Federal Reserve Bank of St. Louis However, this is clearly not the case. The last time interest rates were exceptionally low was during 2003 when they sat at 1% for several quarters before tightening significantly to 5.25%. During 2003, the market’s dividend yield hovered around 1.5%, 25% lower than today’s dividend yield. We can also see the market’s extreme euphoria during the tech bubble when the S&P 500’s dividend yield dipped to 0.98%, half of today’s yield. Perhaps most interesting is the period from 2004 through mid-2006 when the Fed tightened interest rates from 1% to 5.25%. The market’s dividend yield increased around 20%, from 1.5% to 1.8%, but both of these yields are still lower than the market’s yield today. While certain parts of the market are likely more vulnerable than others during a period marked by rising rates, the entire class of dividend paying stocks does not appear bubbly relative to the last 20+ years of market data that we can observe, especially relative to current interest rates. What about the utilities sector? The Conservative Retirees dividend portfolio we oversee has meaningful exposure to utilities and REITs. As you can imagine, Friday wasn’t a great day. While we don’t lose any sleep over our holdings’ abilities to continue paying and growing their dividend payments, we remain mindful of the portfolio’s overall total return potential (income and price return) and continuously look to minimize our downside risk. If utilities and REITs are in a bubble, we should seek returns elsewhere until conditions normalize as a result of rising interest rates. The chart below compares the annual total return of the S&P 500 (blue bars) and the Utilities sector (red bars). The Federal Funds Target Rate (green line) is also displayed to highlight periods of rising and falling rates. Many investors are quick to assume that higher yielding dividend stocks like utilities will be major underperformers over the next five years as interest rates gradually rise. Source: Simply Safe Dividends, Federal Reserve Bank of St. Louis However, we can see that during the last period of rising rates, from 2004 to 2006 when rates increased from 1% to 5.25%, the utilities sector actually outperformed the S&P 500 in each of those years! Despite four straight years of outperformance relative to the market during 2004-2007, utility stocks still significantly outperformed during the 2008 market crash. 2014 was a huge year for the utilities sector, which returned about 30% and easily outpaced the market. Many investors have predicted higher interest rates in each of the past few years, but the Fed has continued delaying, helping utility stocks outperform. However, December 2015 could finally vindicate those expecting higher rates. Not surprisingly, the chart above also shows that utility stocks have return -8.1% YTD, significantly trailing the market’s 3.7% return and reflecting investors’ expectations for a rate hike next month. With rates looking set to move higher, will utility stocks need to meaningfully drop in value to keep their dividend yields relatively attractive for investors? While we can’t predict the future, we can compare the dividend yield of utility stocks today to their yield throughout history. The chart below does just that while overlaying the Federal Funds Target Rate (red line). Utility stocks, as represented by the XLU ETF, closed Friday with a dividend yield of 3.7%. This yield is higher than the 3.4% yield utility stocks had in 2003 when interest rates were 1%, and it’s also higher than the 3.4% yield utility stocks topped out at in 2006 when rates peaked out at 5.25%. Source: Simply Safe Dividends, Federal Reserve Bank of St. Louis The utility sector’s dividend yield has been in a downward trend since 2009, but its current yield appears quite reasonable relative to the last decade and historical interest rates. Once again, we don’t see signs of a bubble here despite Friday’s price shock. Finally, we compared the Utility sector’s dividend yield to the S&P 500’s dividend yield over the last decade. The chart below shows the difference between the two yields. A figure of 2% would mean that the Utility sector’s dividend yield was 200 basis points higher than the S&P 500’s yield (e.g. 5% yield compared to a 3% yield). A lower yield gap suggests that utility stocks could be expensive relative to the market. While the yield premium has come down meaningfully since peaking out at 2.4% in early 2011, its current reading is about in line with where it traded prior to the rate increases that occurred from 2004 through mid-2006. Interestingly, the yield premium fell during this time as utility stocks outperformed the market. Unless cyclical growth stocks really take off and leave utility stocks behind, it’s hard to imagine the yield premium returning to 2.4%. Source: Simply Safe Dividends How Interest Rates Actually Impact Utility Stocks Beyond historical dividend yields and interest rates, remaining focused on companies’ fundamentals is the key to long-term investing success. For this reason, it is important to understand why interest rates are very important to utilities’ actual businesses (not just fickle investor sentiment). First, utilities maintain extremely large debt loads. Constructing and maintaining power plants and infrastructure to deliver electricity and gas are extremely costly activities. The stable cash flows generated by utilities alleviate some of their credit risk, but the regulatory environment in each operating region plays a big role in a utility company’s health. Some companies are able to gain regulatory approval to increase the rates charged to customers to finance the large construction projects and higher borrowing costs they undertake, while others must absorb more of these costs themselves if customers cannot afford higher rates, lowering earnings. Many utilities have benefited from lower interest rates over the last 5+ years, allowing them to cheaply improve their infrastructure and refinance high interest rate debt to improve cash flow generation. Improved cash flow and the lower cost of debt has also enabled some utilities to acquire businesses in non-regulated industries to gain exposure to faster-growing businesses over the past few years, perhaps reducing the sensitivity of their businesses to interest rates. While rising rates make other yield investments relatively more attractive and could gradually increase utilities’ borrowing costs, it is important to remember why interest rates generally rise in the first place. The Fed will only raise rates if it believes the US economy is strengthening and inflationary pressures are gaining steam. In such an environment, consumers are doing well and are more able to afford higher energy prices. For utilities operating in regions with favorable regulation, this means they have a greater ability to pass on their higher borrowing costs resulting onto consumers through higher energy bills, protecting and growing earnings. As we previously showed, during the last tightening period from 2004 through 2006, utility stocks actually outperformed the market in each year! It’s far from a certainty that rising rates over the next few years will be worse for utilities than the rest of the stock market. So, Are Utility Stocks in a Bubble? While the plunge in higher yielding, slower growing companies such as utilities was painful on Friday, it is important to keep the big picture in perspective and remain resistant to swings in market sentiment. Given the world’s fragile state, the Fed seems likely to very gradually raise interest rates, assuming it does indeed start to act in December. Whether rates rise or fall, owning a portfolio of reasonably priced companies that earn solid returns on capital and grow their cash flow (and dividends) over long periods of time will always be a winning strategy. That is what we try to do with our Top 20 Dividend Stocks portfolio , which includes several REITs and utilities. From a historical point of view, dividend stocks do not appear to be in a bubble, but they could decline in the initial months surrounding an interest rate increase like they have in the past . Utilities’ dividend yields also appear reasonable, and these stocks actually outperformed the market during the last period of rising rates from 2004 through 2006. While anything can happen and we are coming off of an unprecedented period of low interest rates, we do not see a bubble today and believe that most utility stocks will continue providing stable income and reasonable downside protection for many portfolios, even if they continue experiencing near-term price volatility.