Tag Archives: utility

Consolidated Edison – Slow And Steady Growth While Bringing Stability To Your Portfolio

Summary Consolidated Edison serves 3.4M customers in the New York City area. ConEd is a Dividend Champion having raised dividends for 41 consecutive years; a starting yield of 3.91% and a 5-yr dividend CAGR of 1.3% brings Chowder Rule to 5.21. In a slow and steady growth sector, ConEd is stable and is planning to grow by investing heavily in the electric and gas infrastructure investments in the next two years. Consolidated Edison Inc (NYSE: ED ) is a regulated electric, gas and steam utility delivery company serving New York City and Westchester County. The company serves 3.4M customers and is an iconic dividend growing company loved for its long track record of not only paying dividends — which it has paid since 1885 — but has raised those dividends for 41 consecutive years. The company operates in three segments: Consolidated Edison Company of New York (CECONY), Orange & Rockland Utility Company (O&R) and Competitive Energy Business. Corporate Profile (from Yahoo Finance) Consolidated Edison, Inc., through its subsidiaries, engages in regulated electric, gas, and steam delivery businesses in the United States. It offers electric services to approximately 3.4 million customers in New York City and Westchester County; gas to approximately 1.1 million customers in Manhattan, the Bronx, and parts of Queens and Westchester County; and steam to approximately 1,700 customers in parts of Manhattan. The company owns 62 area distribution substations and various distribution facilities; 39 transmission substations and 62 area stations; electric generation facilities with an aggregate capacity of 705 megawatts that run with gas and fuel oil; 4,330 miles of mains and 369,339 service lines for natural gas distribution; and 1 steam-electric generating station and 5 steam-only generating stations. It also supplies electricity to approximately 0.3 million customers in southeastern New York, and in adjacent areas of northern New Jersey and northeastern Pennsylvania; and gas to approximately 0.1 million customers in southeastern New York and adjacent areas of northeastern Pennsylvania. The company operates 572 circuit miles of transmission lines; 14 transmission substations; 62 distribution substations; 86,379 in-service line transformers; 3,991 pole miles of overhead distribution lines; and 1,869 miles of underground distribution lines, as well as 1,867 miles of mains and 105,077 service lines for natural gas distribution. In addition, it is involved in the sale and related hedging of electricity to retail customers; and provision of energy-related products and services to wholesale and retail customers. Further, the company develops, owns, and operates renewable and energy infrastructure projects, as well as invests in transmission companies. It primarily sells electricity to industrial, commercial, residential, and governmental customers. The company was founded in 1884 and is based in New York, New York. A Closer Look Consolidated Edison operates in one of the most vibrant and densely populated areas — New York City. Operating with a focus on the transmission and distribution business, the commodity exposure is less than other utility companies in the sector such as Southern Company (NYSE: SO ). The following chart provides an overview of the different segments of ConEd and the contributed earnings per segment. (click to enlarge) (Source: 2015 Wolfe Research Power & Gas Leaders Conference Presentaton ) The regulated nature of the industry has kept the stock performance stable and tempered through rough times in the economy. However, ConEd still has avenues to grow. The company’s forward-looking focus for growth includes: Delivering energy to a growing service area Energy conversion programs Oil-to-gas conversions Development of renewable energy Energy infrastructure investments for electric & gas transmissions and electric & gas storage. (Source: Created by author. Data from Capex Forecast 2014 10-K) One worrying trend that investors need to be aware of is that the utilities sector is seeing continued headwinds in revenue growth. There are various reasons, but the main ones are motivated by increased costs from utility companies to cover operating and overhead costs. In addition, revenue growth headwinds come from a combination of energy conservation, energy efficiency and shift towards independent power generation as renewable energy becomes more affordable and accessible for the end users. The following chart from ConEd shows the changes in electricity usage, which has seen steady declines from both residential and commercial users over the last few years. As electricity is the biggest segment in ConEd’s business, it should be something potential and current investors should stay vigilant about. (click to enlarge) (Image Source: ConEd Credit Suisse Energy Summit Presentation ) Dividend Stock Analysis Financials Expected: A growing revenue, earnings per share and free cash flow year over year looking at a 10-year trend. A manageable amount of debt that can be serviced without affecting future operations. (click to enlarge) (Source: Created by author. Data from Morningstar) (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The utility industry is resilient and has seen a slow and steady rise over the years. Revenues and earnings are fairly constant with year-over-year growth ranging between -0.25% to +0.25%. The debt load is also stable and ED enjoys an “A+” credit rating from S&P. ED has a debt/equity of 1.07 and a current ratio of 0.90. Dividends and Payout Ratios Expected: A growing dividend outpacing inflation rates, with a dividend rate not too high (which might signal an upcoming cut). Low/Manageable payout ratio to indicate that the dividends can be raised comfortably in the future. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: Utility companies are slow and steady growers and are perfectly suited for long-term dividend investors. Consolidated Edison is a Dividend Champion having raised dividends consecutively for 41 years. The 1-, 3-, 5-, and 10-year dividend CAGRs are 2.4%, 1.6%, 1.3%, and 1.1% respectively. Coupled with a current dividend yield of 3.91%, ED has a Chowder Rule number of 5.21. The current payout ratio is 67.7%. The payout ratio falls within the target range of 60%-70%. Outstanding Shares Expected: Either constant or decreasing number of outstanding shares. An increase in share count might signal that the company is diluting its ownership and running into financial trouble. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The number of shares have risen steadily over the years until 2011, but have stabilized since. Book Value and Book Value Growth Expected: Growing book value per share. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The book value is a bright spot in the company’s financials. The book value has steadily increased over the years maintaining a nice upward trajectory. Valuation To determine the valuation, I use the Graham Number, average price-to-earnings, average yield, average price-to-sales, and discounted cash flow. For details on the methodology, click here . The Graham Number for ED with a book value per share of $43.66 and TTM EPS of $3.77 is $60.86. Based on the last closing price, the stock is currently 10.15% overvalued. ED’s 5-year average P/E is 15.34, and the 10-year average P/E is 15.23. Based on the analyst earnings estimate of $4.04, we get a fair value of $61.97 (based on the 5-year average) and $61.53 (based on the 10-year average). ED’s average yield over the past five years was 4.67% and over the past 10 years was 4.99%. Based on the current annual payout of $2.60, that gives us a fair value of $55.67 and $52.10 over the 5- and 10-year periods, respectively. The average 5-year P/S is 2.16 and average 10-year P/S is 2.0. Revenue estimates for next year stand at $21.18 per share, giving a fair value of $45.74 and $42.35 based on 5- and 10-year averages, respectively. The consensus from analysts is that earnings will rise at 2.72% per year over the next five years. If we take a more slightly conservative number at 2.5%, running the three-stage DCF analysis with an 8% discount rate (expected rate of return), we get a fair price of $67.27. The following charts from F.A.S.T. Graphs provide a perspective on the valuation of ED. (click to enlarge) (Source: F.A.S.T. Graphs ) The chart above shows that ED is slightly overvalued. The Estimates section of F.A.S.T. Graphs predicts that at a P/E valuation of 15, the 1-year return would be -6.5%. (click to enlarge) (Source: F.A.S.T. Graphs ) Conclusion Electric utilities in general have seen slower sales industrywide amid a combination of energy conservation, energy efficiency and shift towards independent power generation/natural gas usage. The utility sector is a stable slow-growth sector that is revered during recessions by investors. ConEd fits the bill, as it has slowly and steadily grown the business over many years, although the stock is currently overvalued. Based on the metrics discussed above, if we give equal weight to all metrics, we get a fair value of $58.94. Remember that utilities sector stocks play a very different role in a portfolio — it will not rise fast, bringing amazing capital gains and quick wealth. What utility stocks bring to an investor’s portfolio is inertia and stability while providing steady and reliable income. One added risk for investors is the potential rise of interest rates by the US Fed. Bond substitutes such as utility stocks suffer the most in rising rate environments. Full Disclosure: None. My full list of holdings is available here .

UGI Corporation: Little Bit Of This, Little Bit Of That

Summary UGI Corporation has its hands in many pots, with businesses all around the world. Peeling back the onion reveals that management has maintained control of operations. With manageable debt, high profitability, and below average valuation multiples, investors could pick much worse in the utility sector. UGI Corporation (NYSE: UGI ) is a holding company that operates a variety of businesses involved in the transportation and distribution of energy products. The company has been on an acquisition spree, spending over $2B over the past five years acquiring a vast swath of business lines. Shareholders have rewarded the exuberant spending with outsized returns over the broader utility index. Are more returns set to come or has the company lost direction? What Does UGI Corporation Do? As mentioned, the company owns a substantial interest in a variety of businesses: General Partner of AmeriGas Partners (NYSE: APU ), prior research by me found here International liquid petroleum gas businesses Midstream & Marketing operations (energy services and electric generation businesses) An electric generation segment (ownership interests of approximately 250MW of power generation) A gas utility business (serving nearly a million customers in Pennsylvania and Maryland) Phew. Simple this company is not. The above five operating segments actually simplify a variety of businesses that really don’t deserve to be comingled (revenue from co-ownership of power plants and pipeline building are intertwined in the Midstream & Marketing segment as an example). The AmeriGas’ ownership interest constituted just under half of 2014 revenue and profit, so the importance of this interest to operating results cannot be understated. AmeriGas is a propane distributor, with operations across the vast majority of the United States. Through its distribution network, AmeriGas provides propane to customers who have no real alternative for heating and cooking in their homes and businesses. 2014 was a stellar year for propane due to a colder than average year that drove operating margins due to scarcity of supply – 12.7% operating margins compared to 5.8% operating margins in 2012. Investors should be careful and consider that 2014 should not be a base case scenario for AmeriGas and is rather unlikely to be repeated. 2015 has been shaping up to be an average year in regards to operating results. This weakness year/year is part of the reason why earnings per share are set to fall in fiscal 2015 compared to fiscal 2014 for UGI Corporation. I’d highly recommend reading my prior article on AmeriGas for a deeper understanding, but as an overview, there are quite a few headwinds facing AmeriGas going forward. UGI highlights the main risk in its form 10-K: “Retail propane industry volumes have been declining for several years and no or modest growth in total demand is foreseen in the next several years. Therefore, the Partnership’s ability to grow within the industry is dependent on its ability to acquire other retail distributors and to achieve internal growth, which includes expansion of the Propane Exchange program and the National Accounts program (through which the Partnership encourages multi-location propane users to enter into a supply agreement with it rather than with many suppliers), as well as the success of its sales and marketing programs designed to attract and retain customers.” Retail propane is AmeriGas’ core business and has been declining slowly. This is due to a variety of factors, such as the expansion of natural gas further into rural territories (on a BTU/price basis, propane cannot compete and that is unlikely to change) and shrinking demand from customers due to milder temperatures and customer energy conservation. AmeriGas’ management believes that a propane exchange program (i.e., swapping out bottles for your grill) might help plug the slow leak of lost customers, which I find a stretch. Neither does consolidating the industry more, which isn’t going to stem the demand problem. The UGI International segment is another large contributor to revenue. The division sells LPG products throughout portions of Europe such as France, Belgium, the Netherlands, Austria, etc. Like AmeriGas, these sales are primarily to residential and small businesses that use the gas for heating and cooking. Unfortunately, LPG prices are much higher in Europe than in the United States. This has made electricity, which is immensely more expensive on a BTU basis than LPGs in the United States, a viable competitor to European LPG for heating and cooking in Europe, especially in France. So just like in the United States, customer demand is on a slow, marginal decline barring cold weather spikes: “The LPG markets in France and the Benelux countries are mature, with modest declines in total demand due to competition with other fuels and other energy sources… due to the nuclear power plants, as well as the regulation of electricity prices by the French government, electricity prices in France are generally less expensive than LPG. As a result, electricity has increasingly become a more significant competitor to LPG in France than in other countries where we operate. In addition, government policies and incentives that favor alternative energy sources can result in customers migrating to energy sources other than LPG in both France and the Benelux countries.” As a bright spot, the gas utility segment bears promise. I’m a fan of gas utilities; the environmental risk is much lower but allowed rates of return are generally similar to electric utilities. Gas utilities also have a steady stream of capital expenditures (replacement of pipe) that are easy to pass along to consumers, on which gas utilities are entitled to their fair rate of return. Additionally, being located in Pennsylvania, UGI’s gas utility business is located near many heavy industries such as metal and paper manufacturers. This allows better diversification of revenue away from the residential consumer that some utilities do not benefit from. From a sourcing perspective, being next to Marcellus and Utica shale formations provides a readily available and cheap source of natural gas to sell along to consumers. Being able to provide cheap natural gas prices for local consumers means higher relative demand compared to other areas of the United States. Midstream & Marketing is a growing but convoluted segment. Bundled up in operational results here are the operating results from natural gas liquefaction, LPG storage, energy peaking business (selling stored gas to utilities during times of high demand), pipeline construction, and partial ownership in coal, natural gas, and solar power plants (250MW worth). This makes our jobs as investors incredibly difficult as it becomes tedious to analyze and project future earnings potential. In general, however, this segment is like the others in that it benefits from cold weather spikes in the Northeast, such as during 2014. Peaking businesses can be highly profitable but can also sit on stored LPGs for some time waiting for the opportunity to sell. Cash Flow With all these businesses, how has operational cash flow performed? You might be as surprised as I was to see a fairly healthy cash flow statement. Operational cash flow has been growing and capital expenditures light (which makes sense given the asset-light nature of the retail LPG businesses). Because of strong operational cash flow, UGI would have actually been generating net cash balances excluding its acquisitions, a rarity for companies operating in the utility industries that have been running through cash in a cheap debt, low interest rate environment. At 3x net debt/EBITDA, UGI has much less leverage than most utility peers. Conclusion Trading at a ttm EV/EBITDA of less than 8x, shares appear cheap from that valuation perspective. The variety of businesses here appear to still be well run despite the amalgamation of holdings that management has collected over the past few years. While the company still relies heavily on propane/butane sales, worldwide geographical diversity does limit some of the risk. While I don’t think operating income can expand much from here outside of boosts from cold weather events, management still has plenty of room to bump the dividend to reward shareholders without getting themselves into cash flow problems. If you’re interested in AmeriGas, this might be a safe way to get exposure to the company while getting some worldwide exposure and regulated utility business diversification as well.

Alliant Energy: Management Strategy Looks Solid

Summary Alliant is investing in its future by building new, state-of-the-art power plants. New power-plant buildup has been costly, but debt is manageable and financed at low rates. With a history of stable earnings growth and dividend increases, shares look poised to outperform peers. Alliant Energy (NYSE: LNT ) is a regulated public utility with both electric and natural gas businesses. The company has a substantial presence in the Midwest, with the vast majority of Alliant operations taking place in Iowa and Wisconsin. A long-time outperformer, shares rebounded nicely off 2009 lows, trouncing the total returns of most other utilities. However, the last two years have seen shares just track along with the broader index. Can Alliant Energy return to its strong return profile? Shifting Energy Mix and Future CapEx Plans To comply with federal and state mandates, Alliant has made a big push over the past ten years to move from a coal-dominated power generation mix to one more focused on natural gas and wind. While coal still holds the largest piece of Alliant generation capacity, company management forecasts a major shift by 2024, where coal only constitutes roughly one-third of production. This change will primarily be driven by upcoming company investments in natural gas through its Marshalltown Generating Station (650MW combined cycle natural gas) and an expansion of its Riverside facility (another 650MW combined cycle natural gas facility). (click to enlarge) * Alliant Energy Investor Presentation Once these facilities are built, this will allow the company to shift its capital expenditure away from environmental upgrades and new power plant builds, instead allocating resources towards taking advantage of higher allowed returns through upgrading ATC electric transmission infrastructure (12.8% allowed return on equity). I’m a big fan of Alliant management’s capital expenditure plans and believe this is the way to go for enhancing shareholder returns, while ensuring compliance with possible future enhanced emissions regulations. This strategy is distinctly different from the plans we’ve seen from other Midwestern utilities like Great Plains Energy (NYSE: GXP ) and large nation-wide behemoths like Duke Energy (NYSE: DUK ). Operating Results Regulated electric revenues have stalled, primarily due to falling residential customer sales due to lower overall energy demand. Customer count has remained mostly flat. The big driver has actually been industrial demand, but these larger customers have the advantage of negotiating cheaper electricity from utilities directly, yielding lower margins. On the plus side, Alliant’s industrial customers are primarily in the food manufacturing and chemical businesses, businesses which are traditionally fairly resilient to economic downturns. Gas operations revenues are also down, but not due to falling sales. Like most gas utilities, Alliant has riders that pass along the cost of natural gas to customers, for better or worse. Falling natural gas prices means falling revenue but the company maintains its fixed profit per sale. While revenue has been flat, cash flow generation has been exceptionally strong for Alliant. The company has been spending this cash quicker than it comes in though, with heavy investments in new generation ($300M+ annual for Marshalltown/Riverside expected in 2015-2017) and electric transmission. (click to enlarge) * Alliant Energy Investor Presentation Alliant has made the decision to take advantage of its credit ratings and low interest rates and make these upgrades and investments now. Long-term debt has grown $1B from 2011 to the present, now standing at $3.7B. However, net debt/EBITDA is still 3.6x, in line with utility averages. There shouldn’t be much risk here, especially as operating income rises and capital expenditures fall over the next five-ten years. Conclusion Alliant is investing in its future, committed to shifting its power-generation mix and investing its operating cash flow in high-margin businesses. With a current dividend yield of 3.70% and a history of healthy annual dividend increases, shareholders seem set to be rewarded handsomely. 5-6% annual dividend increases over the next three-five years seem likely. With expected 2016 earnings per share of approximately $3.85, shares trade at just 15.6x 2016 earnings. There looks to be substantial value here with a fair margin of safety compared to most alternatives in the utility sector. Primary risk for shares are standard to most utilities: interest rate risk, risks related to allowed regulated returns or customer loss in the company’s service area, and a general revaluation within the utility sector that brings earnings multiples down across the board.