Tag Archives: utility

Quant Strategies – YTD Performance Update

Now, that equity markets have experienced a nice 10%+ correction this year I thought it would be of value to look at the performance of various quant strategies year to date, especially during a tough year for stocks as 2015 has been. For explanations of the various quant strategies see the portfolios page. All equity portfolios consist of 25 stocks and were formed at the end of 2014. No changes in the holdings since that time. In the table below I list various quant strategies along with their YTD performance and drawdowns. Also, listed are various benchmark indices (highlighted in yellow). In table above, strategies that have outperformed their benchmark indices are shown in green. As you may expect, the results are mixed, some strategies outperformed, some did not. 4 of the 7 equity strategies listed outperformed both U.S. and International stocks. The consumer staples value strategy (CS Value) has led the way with a 14% YTD return plus a very low drawdown. The laggard has been trending value (TV2) at -9.59%. This is not surprising when you look at the historical data. Momentum strategies can be quite volatile. Microcaps have also done well at 8.88% YTD. Enhanced Yield (EY) and Utility value have also lagged in performance. The ‘build your own index’ strategy (large SHY) has outperformed the SPY but with higher drawdown. Yield strategies in general have had a rough time in 2015. I also listed the TAA bond strategy in the table which has slightly underperformed the Vanguard Total Bond Market ETF (NYSEARCA: BND ) and outperformed the V anguard Total International Bond ETF (NASDAQ: BNDX ). That’s it. A quick look at some 2015 YTD performance figures for various quant strategies. In my next post I’ll take a look at a very simple way to further enhance quant strategy performance. Share this article with a colleague

ITC Holdings: Growth Comes At A Price

Summary Transmissions business carries less risk and higher allowed returns than other utilities. Dividend is slated to grow at a 10-15% annual pace through 2018 by management. ITC Holdings is highly leveraged and burns through cash – a change to allowed returns could be disastrous. ITC Holdings (NYSE: ITC ) is the largest electricity transmission company in the United States, operating out of the Midwest. Current operations sprawl out from the center of the country, impacting dozens of states. Unlike your typical regulated electric utility that directly produces energy to provide electricity to customers, ITC focuses fully on grid infrastructure. Electric transmission assets have been historically under-maintained, resulting in significant transmission constraints and stress on ageing equipment. To combat this, the regulatory environment has shifted to companies like ITC to fix these issues while receiving a stable, regulated rate of return. Given ITC’s estimates of $160-240B in additional necessary upgrades to infrastructure by 2030, substantial opportunity exists for utilities to earn a fair return on invested capital upgrading these assets. This business model has been a long-term outperformer. Looking back ten years, shares have trounced utility peers but have begun to underperform recently. Is this a healthy needed sell-off or an opportunity for investors to buy in before the next leg up in share price? Not Your Grandfather’s Utility Your typical state-regulated, power-producing utility has a tough time. Rates it can charge are set at fixed rates in between rate cases it makes with state regulators, hopefully with various riders in place that allow recovery of necessary capital expenditures or changes in commodity prices. In nearly every case, electric utilities experience “regulatory lag” – a gap between capital spending and eventual recovery. Disallowances are always a risk. Further exasperating utility management, a utility might make an investment assuming a return on equity that never materializes or an incredibly long amortization period that stretches out the timeline of recovery. Political gamesmanship between the utility, regulators, and the public that bears the costs is always present. ITC Holdings is instead governed by FERC, the Federal Energy Regulatory Commission. Working with the Feds directly avoids a large portion of the games played in the rate-making process. Regulatory lag isn’t as much of a problem as FERC rate-setting is forward-looking with annual adjustments. Further benefitting ITC is the much higher allowed returns on transmission infrastructure. Most publicly-traded utilities have seen their allowed return on equities plummet over the past decade to approximately 10%, give or take a half percentage either way. Allowed returns for transmission companies like ITC is in the 12% range depending on region. In a nutshell, this makes ITC a much more profitable business than most utility peers, with profit and operating margins that energy producers like Duke Energy (NYSE: DUK ) could only dream of. In spite of risk to drops in allowed return on equity (FERC dropped allowed return on equity on New England assets to 11.7%, setting off warning bells across transmission utilities), the company should enjoy meaningful returns above and beyond standard utilities for some time. Further cementing ITC’s advantages over electric utilities, transmission assets are simple. By and large, they are simply pole and wire assets with supporting infrastructure. The environmental and regulatory risk simply isn’t as present as it is for power-generating utilities. There is no nuclear waste requiring disposal or possible coal ash basin breaches to worry about. Operating Earnings The growth story is obvious here; you won’t find many other companies in the utilities segment growing at over 12% compound annual growth rate. Annual revenue growth is expected to continue at this pace over the next five years as ITC continues to take on projects. Operations and maintenance expenses have actually stayed relatively flat, indicative that maintenance costs are minimal for new transmission infrastructure once updated. Consistently better than 50% operating margins are stellar and more indicative of a company like Apple (NASDAQ: AAPL ) than a regulated utility. Getting a piece of these strong results doesn’t come cheap, because at more than 13x ttm EV/EBITDA, shares trade at a 30% premium to the broader utility industry. Serial Debtor Issue? If anything should concern investors, it is the rapid rise of the company’s debt. The company has breached $4B in debt compared to just $2.5B in 2010. Net debt/EBITDA of slightly over 5x has held steady as ITC’s earnings have grown as well, but this is a substantial amount of leverage as the company pours significant money into capital expenditures. Credit ratings are stable investment grade, but all ratings agencies note the risks in this heavy spending. A deterioration in the company’s regulatory or operating environment (increased regulatory lag, lowered allowed return on equity by regulators, litigation, rising interest rates) could stunt ITC’s cash flow which would hamstring further investment. Any company that perpetually issues hundreds of millions in debt year after year, especially one as small as ITC Holdings, should make investors pause and consider possible implications. Conclusion The small current dividend yield of 2.26% shouldn’t scare away investors. Per management’s 2014-2018 guidance, 10-15% annual dividend increases are to be expected. If management executes and hits the high end of this dividend growth target (as it did in 2015), your yield-on-cost would be 3.43% at the end of 2018, which would be a respectable number that you may not get by buying a slow-growing 3% yielder today. Additionally, ITC’s share repurchase program is rather unique in the utility industry, one that is most often plagued by dilutive equity issuance every few years that is never offset by buyback programs. However, the company’s high degree of leverage, price premium to other utilities, risk of more competition for projects, and uncertainty regarding future allowed returns on electric transmission infrastructure weigh heavily on my ability to issue a buy recommendation.

IDACORP: Consistent Utility Outperformer Still Looks Solid

Summary IDACORP has outperformed utility benchmarks on one year, five year, and ten year timeframes. Idaho’s recovery from the recession has been incredibly resilient, helping the utility perform above peer averages. The dividend yield isn’t amazing, but shareholders should expect 5% annual increases over the next five years. IDACORP (NYSE: IDA ) provides electric utility services to over five hundred thousand customers in southern Idaho and eastern Oregon. Idaho has been a relatively strong state coming out of the recession, maintaining below average unemployment while adding healthy, higher-paying jobs and maintaining a pro-business environment. These factors have combined with prudent management style from IDACORP has resulted in a company with a rapidly rising dividend in a normally benign sector. This performance has elevated shares, bringing them onto the radar for many investors. Those who got in early on this tiny utility with just 3,600MW of capacity have been awarded with solid gains as the shares have continued to repeatedly trounce utility benchmarks year in and year out. Is the long-term outlook for IDACORP as favorable as its past? Non-ownership Operational Risk Idaho Power generates nearly half of its power from coal-fired generation. Beyond the general risks of coal (shift to renewables, coal ash, regulatory risk, high capital expenditures to bring plants into emissions compliance), Idaho Power also bears the risk of not having a controlling interest. The three coal plants in which it has an interest are operated by Portland General (PGE), PacifiCorp, and NV Energy. This non-controlling interest gives Idaho Power limited control in operations, but it also gives the company an easier out if does choose to exit coal operations by being able to sell its partial stakes. As for continuing coal operations, the Boardman plant, as outlined in my article on Portland General , is already slated to be closed by 2020. Based on Idaho Power’s 2013 review, they will continue to undertake operations at the other two plants for the foreseeable future. Operating Results Roughly half of IDACORP’s power generation is generated from hydroelectricity generated along the Snake River and its tributaries. When water conditions are poor (due to poor snowpack melt in the spring, low rainfall, or a combination of both), hydroelectric generation falls. In order to fill these gaps, the company must usually purchase power on the open market to fill the gaps. Likewise when the rivers are strong, IDACORP has excess power to sell on the open market for additional revenue. Idaho has been experiencing historically warm and dry conditions for the past several years, which has led to a decrease in yearly power generation from its hydroelectric plants. Purchased power will touch $250M in 2015, up $80M from 2010 levels. As an offset to this, dry and hot weather means higher energy demand from IDACORP customers. Peak energy usage for the utility generally comes in the summer as customers run their air conditioners and irrigation pumps, dry weather exasperating the power draw needed to run these key items. In spite of this gross margin weakness, primarily due to increased purchased power, operating margins have been expanding. This has been primarily due to management chokehold on operations and maintenance costs. Cash from operations has been growing while capital expenditures have been falling. Cash burn has been marginal, with long-term debt barely moving over recent years. The current dividend yield of 2.84% is highly sustainable in my view and future growth is easily supported by operational cash flow. Conclusion IDACORP is a small utility that does trade at a fair premium to peers. The dividend yield is quite small but has been growing, especially in the last few years. The company can easily support future dividend increases so I expect that the company will bump the dividend meaningfully over the next five years, likely in the 5% range. While I might not advocate buying at current prices near 52-week highs, it definitely deserves to be on investor watch lists looking for steady, reliable future returns.