Tag Archives: utility

Exploring The Highest-Yielding, Dividend-Raising Utility

In a screen for the highest-yielding, dividend-raising utility I came across a Houston-based company with a 5%+ dividend yield. This company has provided solid investment results over the past decade. This article looks at what you might expect moving forward based on the company’s commentary. For dividend-oriented investors, David Fish’s list of Dividend Champions, Contenders and Challenges is the place to get your bearings. It’s nice because it provides you with a great subset of the types of securities you might be looking for: companies that have not only paid but also increased their dividend payments for at least 5, 10 and 25 years. Still, there are hundreds of names from which you can explore. As such, it can be helpful to whittle down the list to discover pockets of the investing world one by one. As an example, you might organize the list by utilities and then by “current” dividend yield. Naturally screens come with a bevy of limitations, but for exploration sake they work quite well. If you completed this exercise, you would notice that CenterPoint Energy (NYSE: CNP ) happened to be the highest-yielding, dividend-raising utility. Let’s explore. Tracing its roots back to 1866 , CenterPoint Energy began as the Houston Gas Light Company. Today the company has more than 7,400 employees serving more than 5 million customers. The business operates in four basic areas: natural gas distribution, electric transmission, natural gas sales and heating and cooling services. The largest segment is the Texas utility serving the Houston area, hence the utility category. However, the company also has a 55.4% limited partner interest in Enable Midstream Partners (NYSE: ENBL ), a natural gas and crude oil infrastructure pipeline. Incidentally, this also explains why CenterPoint has an above average yield – even when compared to other utilities. The payout ratio is well above average, and the share price has declined materially during the last year. Let’s take a look at the company’s history moving from 2005 through 2014:   CNP Revenue Growth -0.6% Start Profit Margin 2.3% End Profit Margin 6.6% Earnings Growth 11.7% Yearly Share Count 3.7% EPS Growth 8.7% Start P/E 19 End P/E 17 Share Price Growth 6.9% % Of Divs Collected 54% Start Payout % 60% End Payout % 67% Dividend Growth 10.1% Total Return 10.0% The above table demonstrates an interesting story. On the top line the company actually had lower revenues in 2014 as compared to 2005. Yet this alone did not prevent the company from generating solid returns. The quality of those sales improved dramatically, resulting in total earnings growth of nearly 12% per year. Ordinarily this number is boosted by a reduction in share count. In the case of utilities, the opposite usually occurs. CenterPoint Energy has been no exception: increasing its common shares outstanding from about 310 million in 2005 to almost 430 million last year. As such, the earnings-per-share growth trailed total company profitability – leading to almost 9% average annual increases. Investors were willing to pay a lower valuation at the end of the period, resulting in 6.9% yearly capital appreciation. Moreover, investors saw a 3% starting dividend yield grow by 10% annually, resulting in total returns of about 10% per annum. In other words, despite the lack of revenue growth and P/E compression, shareholders still would have enjoyed a solid return. This was a direct result of strong underlying earnings growth and a solid and increasing dividend payment. Moving forward, looking at the investment with a similar lens can be helpful. Since the end of 2014, both the share price and expected earnings have declined materially as a result of the broader energy environment. For this fiscal year the company has provided full-year earnings guidance of $1.00 to $1.10 per diluted share – well below the $1.40 earned last year. Still, the company has indicated that it expects to keep the dividend at its current rate, resulting in a 90%+ payout ratio for the time being (this simultaneously equates to 60% to 70% utility operations payout ratio). Moreover, CenterPoint has indicated that it expects to grow its dividend in-line with EPS growth (forecasted at 4% to 6% annually) through 2018. This isn’t speculation on my part or a collection of analyst’s estimates. Instead, its what the company is telling you to expect. Granted they could certainly turn out to be incorrect, but it should be somewhat reassuring given their greater stakes, more to lose, higher company knowledge, etc. Here’s what the next three years of dividend payments could look like with 5% annual growth: 2016 = $1.04 2017 = $1.09 2018 = $1.15 In total an investor might expect to collect $3.28 in aggregate dividend payments, or roughly 18% of the recent share price. Without any capital appreciation whatsoever, this would equate to 5.6% annualized returns. With a future earnings multiple of say 17, this would equate to a total yearly gain of about 8.9% over the three-year period. This is how I’d begin to think about an investment in CenterPoint Energy. You might perform a similar screen and come across the company. Yet this alone does not mean that it’s a worthwhile opportunity. Just because a company has an above average yield doesn’t mean that it’s a great investment. There are other factors at play. However, it does mean that the “investing bar” is relatively lower. A higher starting dividend yield, especially when coupled with reasonable growth, means that a good portion of your return will be generated via cash received. In this case you could see 5% or 6% annual returns without any capital appreciation. From there, if capital appreciation does come along, your investment returns start to approach the double digits. Finally, it’s important to be prudent in these assumptions as the slower growing nature of the business creates an out-sized emphasis on the valuation paid. You could see years of slow or moderate growth outweighed by compression in the earnings multiple. As such, a cautious approach is likely most sensible: expecting to receive a solid and above average dividend yield without the simultaneous anticipation of wide price swings to the upside.

Southern Company – Rising Infrastructure Assets But Look Out For Some Challenging Quarters

Summary Southern Company is one of the largest utilities in America. Will grow to #2 spot by customer count after the AGL Resources purchase. Southern announced its plan to acquire AGL Resources for $8B cash – fueled by debt and equity issuance. The company is a dividend contender having raised dividends for 15 consecutive years; 5-yr dividend CAGR is 3.7% and Chowder Rule is 8.56. The Southern Company (NYSE: SO ) is one of the largest utilities company in America. The company serves more than 4.4 million customers and has approximately 46,000 megawatts of generating capacity serving the Southeast through its subsidiaries. Subsidiaries include electric utilities in four states – Alabama Power, Georgia Power, Gulf Power, and Mississippi Power; a growing, competitive generation company – Southern Power; a licensed operator of three nuclear generating plants – Southern Nuclear; and fiber optics and wireless communications – Southern Telecom and SouthernLINC Wireless, respectively. (Source: September 2015 Southern Company Overview Presentation ) In August 2015, Southern Company announced that it will be acquiring AGL Resources Inc. (NYSE: GAS ) in an $8B cash deal. This combined company will shift Southern from being an electric-only utility company to an electric-and-gas utility company. The customer base is expected to double with this move and pushes Southern to become the second largest utility company in America (by customer count), if the deal is approved. Corporate Profile (from Yahoo Finance) The Southern Company, together with its subsidiaries, operates as a public electric utility company. It is involved in the generation, transmission, and distribution of electricity through coal, nuclear, oil and gas, and hydro resources in the states of Alabama, Georgia, Florida, and Mississippi. The company also constructs, acquires, owns, and manages generation assets, including renewable energy projects. As of December 31, 2014, it operated 33 hydroelectric generating stations, 33 fossil fuel generating stations, 3 nuclear generating stations, 13 combined cycle/cogeneration stations, 9 solar facilities, 1 biomass facility, and 1 landfill gas facility. The company also provides digital wireless communications services with various communication options, including push to talk, cellular service, text messaging, wireless Internet access, and wireless data; and wholesale fiber optic solutions to telecommunication providers in the Southeast. The Southern Company was founded in 1945 and is headquartered in Atlanta, Georgia. A Closer Look The Southern Company has remained focused as an electric utility company through the years. The company has remained a heavy user of dirty fuels such as coal (accounts up to 42%) for its power generation over the years, but has started transitioning to cleaner resources including natural gas, solar and wind. This move will also be welcomed as the company aligns itself with the US government mandate targeting power plants to cut carbon emissions by 32% (by 2030) on the 2005 levels. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) Acquisition of AGL Resources Inc. In August 2015, Southern Company announced a plan to acquire AGL Resources Inc. for about $8B in cash, fortifying SO’s assets with the natural gas infrastructure. AGL Resources distributes gas in Georgia, Illinois, Virginia, New Jersey, Florida, Tennessee and Maryland. Southern Co. owns utilities in Georgia, Alabama, Florida and Mississippi. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) This move lowers SO’s dependence on power generation and pushes SO to the #2 spot in the utility sector by customer count after Exelon Corp. (NYSE: EXC ). The combined company will operate 200,000 miles of electric lines and 80,000 miles of gas pipelines. The deal is expected to close in the second half of 2016. Southern Company will be issuing $3B in new stock and also tapping into the debt markets to finance the merger. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) The deal is expected to raise the long-term EPS growth rates by 4-5%. In addition, the dividend growth is expected to rise faster than current rates. 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 -0.3% to +0.15%. The debt load is also stable and SO enjoys a ‘A-‘ credit rating from S&P. SO has a debt/equity of 1.36 and a current ratio of 0.80. Those numbers can be expected to change significantly over the course of next year or two as the AGL purchase moves closer to closing. 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. Southern Company is a Dividend Contender having raised dividends consecutively for 15 years. The 1-, 3-, 5-, and 10-year dividend CAGRs are 3.5%, 3.6%, 3.7%, and 39% respectively. Coupled with a current dividend yield of 4.86%, SO has a Chowder Rule number of 8.56. The current payout ratio is 89%. 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 and are expected to rise more as the company intends to issue $3B of new equity to finance the AGL deal – approx 66M new shares based on current price, an increase in the number of outstanding shares by ~7%. 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, although we can expect this to stumble when more debt and shares are issued in the coming years. 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 SO with a book value per share of $22.22 and TTM EPS of $2.35 is $34.28. Based on the last closing price, the stock is currently 30% overvalued. SO’s 5-year average P/E is 18.92, and the 10-year average P/E is 17.80. Based on the analyst earnings estimate of $2.94, we get a fair value of $55.62 (based on the 5-year average) and $52.33 (based on the 10-year average). SO’s average yield over the past five years was 4.60% and over the past 10 years was 4.61%. Based on the current annual payout of $2.17, that gives us a fair value of $47.17 and $47.07 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 3.58% per year over the next five years. If we take a more conservative number at 3%, running the three-stage DCF analysis with an 8% discount rate (expected rate of return), we get a fair price of $36.73. The following charts from F.A.S.T. Graphs provide a perspective on the valuation of SO. (click to enlarge) (Source: F.A.S.T. Graphs ) The chart above shows that SO is slightly undervalued. The Estimates section of F.A.S.T. Graphs predicts that at a P/E valuation of 15, the 1-year return would be 2.75%. (click to enlarge) (Source: F.A.S.T. Graphs ) Conclusion Electric utilities in general have seen slower sales industry-wide amid a combination of energy conservation, energy efficiency and shift towards independent power generation/natural gas usage. Coupled with the new regulations from the US government to reduce carbon emissions, electric utilities have started focusing a shift away from dirty fuels such as coal. Southern Company still relies heavily on coal, but has started focusing on cleaner energy alternatives to meet the target. In a move to diversify and fortify its assets, the company is moving to acquire AGL Resources Inc. in a deal financed by new share and debt issuance. While this is good for the overall company’s business, in the short term (over the course of next few quarters/years) some balance sheet damage can be expected as the company takes on more debt and investors see share dilution. An 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. Based on the metrics discussed above, if we give equal weight to all metrics, we get a fair value of $45.31. Full Disclosure: None. My full list of holdings is available here .

Portland General: Utility With Some Promise

Summary Short-term, headwinds exist related to heavy capital expenditures and poor weather forecasts. Long-term, spending should be down and income up, freeing up cash flow for shareholder returns. Two natural gas-fired plant openings, one in 2016 and one in 2020, will be key to company success. Portland General Electric Company (NYSE: POR ) is an electric utility that operates wholly within the state of Oregon, providing power to nearly 50% of Oregonians with over 3,400MW of available energy generation. Primarily serving residential customers, the company’s bottom line has been bolstered by domestic migration to the Northwest. From 2010-2014, the Portland metropolitan area added over one hundred thousand new residents – an annual growth rate of 5.2%. This strong local population growth has helped bolster earnings results and shareholder returns, with investors reaping 100% in total return over the past five years, roughly double the return of utilities indexes. Does Portland General have more room to run or has the utility run its course? Future Is Natural Gas, Profit Is With Hydro * Portland General September 2015 Investor Presentation Portland General has a diverse portfolio of power generation. Including purchased power, 36% of power was created from renewable sources and an additional 25% generated from cleaner-burning natural gas. This is going to change drastically over the next few years, however. Given Oregon’s progressive nature, it wasn’t a surprise to see Oregon residents campaign for clean power. Management quickly bowed to customer and political pressure, leading to plans for the elimination of all coal-fired generation in Oregon. Under the Boardman 2020 plan, Portland General will close its 518MW Boardman coal asset by 2020, instead building a natural gas facility on the site. This will be a costly project, but doing so will save the company $470M in required upgrades to meet emissions guidelines had the plant remained open until 2040 as previously guided. The risk here is that the new plant is delayed and is not completed by the time Boardman is scheduled to be mothballed. Portland General relies heavily on the Boardman plant to produce electricity as coal-fired generation is in many cases the cheapest and most reliable asset the company has. Coal represents 16.5% of available resource capacity but generated 28% of the load in 2015 and is run at capacity nearly constantly. The company’s peak power load in 2014 was 3866MW which was already above currently available company-owned power generation and the shortfall from the Boardman plant closure could force Portland General to increase purchased power during peak times. While these costs will inevitably be passed along to the consumer because of Portland General’s clauses with the Public Utility Commission of Oregon, higher prices could still cause a slack in energy demand and bad press is never good for the bottom line. The company’s Carty Generating Station, slated to be completed in 2017, will help cover future shortfalls built is imperative for investors to track how the new Boardman facility’s construction is proceeding over the coming years. This risk is noted in the company’s 10-K: “Beyond 2018, PGE may need additional resources in order to meet the 2020 and 2025 RPS requirements and to replace energy from Boardman, which is scheduled to cease coal-fired operations in 2020. Additional post-2018 actions may also be needed to offset expiring power purchase agreements and to back-up variable energy resources, such as wind generation facilities. These actions are expected to be identified in a future IRP. PGE expects to file its next IRP with the OPUC in 2016.” – Portland General, 2014 Form 10-K From a profitability standpoint, the key to the company’s energy costs however is hydroelectricity. Hydroelectric generation can be the lowest cost source of generation for Portland General if conditions are right. The state of the Deschutes and Clackamas Rivers (tributaries of the Columbia River) is key. Both of these rivers’ headwaters are fed by the Cascades, a mountain range spanning from Canada to Northern California. In general, the greater the snowfall, the better the power generation is for hydroelectric when the spring thaw comes. Unfortunately for Portland General shareholders and highlighted in a recent prior SeekingAlpha article by Tristan Brown , weather models show lower than average snowfall likely for Oregon, along with a more mild winter in regards to temperature. This presents a double whammy for Portland General in the form of higher energy costs and lower revenue in the winter months during which customers typically draw around 10-15% more electricity than in the summer months. Past Operating Results (click to enlarge) Operating results have been steady and rather uneventful over the past five years (my own estimates used for the back half of 2015). Of note however is depreciation/amortization costs have been increasing dramatically due to the large capital investments the company has been making over the past five years, developing relatively more expensive wind/solar farms and the costs associated with the Carty Generating Station. Overall, this is steady-as-she-goes results that utility investors like to see. (click to enlarge) Frequent readers of my utilities research know that I look for solid coverage of capital expenditures and dividends from operating cash flow for mature utilities. Starting in 2013, Portland General reversed course and begun stepping up the leverage as capital expenditures rose for the natural gas plants at the Carty Generation Station and the old Boardman location. To fund this, Portland General issued $865M in long-term debt in 2013/2014 and also issued $67M worth of common stock in 2013 to cover the cash flow gaps. While this picture looks currently worrisome, it should moderate over time. Capital expenditures are expected to fall from the $600-650M range in 2015 to $289M in 2019, back to levels we saw in 2011/2012 when cash flow was positive. Unfortunately, Portland General won’t see much recovery in the form of increased rates because of offsetting factors, based on the overall breakdown of the 2016 rate case filing: (click to enlarge) Conclusion Portland General saw a little bit more renewed interest after the 7% dividend increase in 2015, well in excess of 2% annual growth from 2009-2014. In regards to operating income, however, 2016 looks unclear given the poor weather outlook. Earnings per share are likely to be flat to down in 2015/2016, so I would not expect a repeat of that hefty 2014 dividend increase. Before entering a position, I would like to see the valuation come down along with more visibility on completion of the two big natural gas facilities (early 2016 should give excellent insight into schedule on Carty Generation Station). Overall, however, shares are quite fairly valued given the long-term prospects of the region. Being long won’t hurt you.