Tag Archives: utility

Duke – All Set To Deliver Growth Going Forward

Summary Company’s increased focus on regulated operations will drive future growth. Duke faces challenges in international segments, which could weigh on earnings in the near term. Growth will stay strong in long term, backed by company’s domestic regulated operations. Stock’s current valuation stays compelling as it is trading at a cheap forward P/E of 13.9x. Duke stays an impressive investment prospect for income-hunting investors, as it offers a solid dividend yield of 4.8%. Duke Energy (NYSE: DUK ) stays a core utility stock for income-hunting investors, as it offers a solid yield of 4.8% , above the industry average of 4%, and has a solid fundamental outlook. I think Duke is a high quality, large utility cap utility with a healthy and visible path towards the average EPS growth rate of 5% through 2019; the company’s low-risk domestic regulated business investments will drive its future growth. Moreover, the company’s strong rate base growth through 2019, along with its plan to hold operational and maintenance ((O&M)) expenses flat through 2016 will augur well for its earnings and dividend growth in the coming years. Also, the stock’s current valuation stays cheap; I think the stock should trade in line with its industry’s average P/E of 15.9x. Despite the fact that the company is facing challenges at its international segment, Duke Energy International, which may affect its performance in upcoming quarters, I think Duke is one of the best large cap defensive utility stocks. Growth Catalysts Duke has a solid fundamental outlook, and the company has been working to strengthen its future earnings growth. I think the company has taken the right strategic decisions in recent quarters, including repatriating cash from the international segment and the sale of Midwest assets, which will have a favorable impact on its performance going forward. Also, the company’s increasing focus on the core domestic regulated operations, which contributed almost 90% towards its total earnings, will improve its business risk profile. The company expects to enjoy EPS growth rate in a range of 4%-6% in future, which will be supported by its $42 billion capital investment plan through 2019. Going forward, attractive regulated investments including natural gas pipeline, NCEMPA asset acquisition and accelerated infrastructure investment, will drive its future growth. The company recently completed the $1.25 billion NCEMPA asset purchase, earlier than expected, which will have a positive impact of $0.04 per share on the 2015 EPS. Separately, if Duke moves ahead with its plan to file a new grid modernization plan in Indiana by the end of 2015, it will bode well for its stock price. Furthermore, the company is correctly taking initiatives to expand its renewable energy fleet, which will allow it to comply with the increasing environmental regulations to reduce carbon emissions and maintain reliable cost effective power generation assets. The company has been working on different solar and wind energy projects; Duke plans to add 500MW of solar capacity over the next ten years. Given the company’s consistent emission reduction efforts, the company has successfully lowered CO2 by 22% since 2005 through the transition to natural gas fleet, retirement of older coal units and investment in renewable energy sources. The company is moving ahead nicely to meet emission reduction by 32% by 2030. To further strengthen and support future growth, I think the company should focus more on renewable energy projects and make new investments towards natural gas reserves, which will offer rate base growth. Despite the strong performance of the company’s domestic regulated segment, its international segment continues to face challenges, which remains a concern for investors. Brazil’s economic and hydro challenges, lower oil prices and foreign exchange headwinds continue to weigh on the company’s consolidated EPS. The company needs to announce some additional opportunities around infrastructure development and acquisitions to offset the weakness of its international business operations. Also, the Brazilian government’s recent announcement to help companies like Duke, who have to dispatch thermal plants before hydro plants, could help the company’s international segment’s operations. However, I think that if the performance of the international segment does not improve in the upcoming quarters, the company needs to consider the option of selling its international operations, which will allow it to focus more on high quality domestic regulated operations, which will also augur well for its stock price. Summation Duke is positioned well to deliver healthy growth in future years. The company’s increased focus on regulated operations, along with robust capital investment profile through 2019, will drive its future growth. The company faces challenges in its international segments, which could weigh on its earnings in the near term, but in the long term, growth will stay strong, backed by its domestic regulated operations. The stock’s current valuation stays compelling as it is trading at a cheap forward P/E of 13.9x , versus the utility industry forward P/E of 15.9x ; in my opinion, Duke should at least be in line with its industry average, given its constructive regulatory environment, above average earnings growth and accelerating dividend growth. Duke stays an impressive investment prospect for income-hunting investors, as it offers a solid dividend yield of 4.8% at compelling valuation. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

XLP Has Numbers For Volatility And Correlation, But It Could Be Better

Summary The portfolio used by XLP isn’t optimized for the best possible performance. I love that the portfolio isn’t afraid to hold producers of addictive substances, but where is the BUD? The expense ratio is fairly solid at .15% and the yield isn’t too bad for an ETF used as a small allocation to overweight the sector. I’d like to see XLP increase the number of holdings within the ETF to reduce the concentrated risk of individual holdings. The low beta reflects a combination of mediocre correlation and low volatility which makes the fund a reasonable fit for a small allocation. Investors should be seeking to improve their risk-adjusted returns. I’m a big fan of using ETFs to achieve the risk-adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio, and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on XLP is .15%. I’d like to see a little lower on domestic equity but for a sector-specific ETF, this is still within reason. Yield The ETF is yielding 2.58%. That isn’t enough for a large position in a dividend growth investor’s portfolio, but it is not low enough to really damage the dividend performance of an investor’s portfolio if it is simply being used to create a slight overweight on the sector due to the lower volatility of this sector. Allocations by Industry The following chart breaks down the allocations by each sector: The heaviest exposures are to food and retailing of staples with beverages also coming in as a “very heavy weight”. All around, it should be clear that the goal of this portfolio is to focus on companies that sell products that will maintain strong demand even if the economy is not performing very well. Accordingly, these companies as a group are less volatile than the broader market. Top Holdings The following chart breaks down the top 10 holdings in the fund: After seeing the beverage sector coming at over 18% of the portfolio, I was expecting PepsiCo (NYSE: PEP ) to have a slightly higher weighting. There are a few other things that surprised me as well though. For instance, CVS Health Corporation (NYSE: CVS ) has a higher weighting than Wal-Mart (NYSE: WMT ). I would have expected Wal-Mart to get a slightly higher allocation. I also would have expected Target (NYSE: TGT ) to get at least a small exposure in the portfolio, but when I downloaded the entire list of holdings it was not present. For tobacco being just over 15% of the portfolio, how about some alcohol exposure? I would have expected Anheuser-Busch (NYSE: BUD ) to merit a place somewhere in the list since the goal is to have companies that can continue to make sales even if the market turns down. Perhaps I’m being cynical to think I’d like to own a large company that sells low-cost alcohol as part of a strategy for hedging against a weak economy which can often include high levels of unemployment. It may be cynical, but it is also prudent financial planning. Despite my rationale for including BUD, it is not listed in the portfolio either. The portfolio has a total of only 38 holdings which is also lower than I would expect for an ETF whose primary purpose is to lower the volatility of the portfolio. Building the Portfolio This hypothetical portfolio has a moderately aggressive allocation for the middle-aged investor. Only 30% of the total portfolio value is placed in bonds and a third of that bond allocation is given to high-yield bonds. This portfolio is probably taking on more risk than would be appropriate for many retiring investors since the volatility on equity can be so high. However, the diversification within the portfolio is fairly solid. Long-term treasuries work nicely with major market indexes, and I’ve designed this hypothetical portfolio without putting in the allocation I normally would for REITs on the assumption that the hypothetical portfolio is not going to be tax exempt. Hopefully, investors will be keeping at least a material portion of their investment portfolio in tax-advantaged accounts. The portfolio assumes frequent rebalancing which would be a problem for short-term trading outside of tax-advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. (click to enlarge) A quick rundown of the portfolio The two bond funds in the portfolio are PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ) for high yield shorter-term debt and iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) for longer-term treasury debt. TLT should be useful for the highly negative correlation it provides relative to the equity positions. HYS on the other hand is attempting to produce more current income with less duration risk by taking on some credit risk. XLP is used to make the portfolio overweight on consumer staples with a goal of providing more stability to the equity portion of the portfolio. iShares U.S. Utilities ETF (NYSEARCA: IDU ) is used to create a significant utility allocation for the portfolio to give it a higher dividend yield and help it produce more income. I find the utility sector often has some desirable risk characteristics that make it worth at least considering for an overweight representation in a portfolio. iShares MSCI EAFE Small-Cap ETF (NYSEARCA: SCZ ) is used to provide some international diversification to the portfolio by giving it holdings in the foreign small-cap space. The core of the portfolio comes from simple exposure to the S&P 500 via SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), though I would suggest that investors creating a new portfolio and not tied into an ETF for that large domestic position should consider the alternative by Vanguard – Vanguard S&P 500 ETF (NYSEARCA: VOO ) – which offers similar holdings and a lower expense ratio. I have yet to see any good argument for not using or another very similar fund as the core of a portfolio. In this piece I’m using SPY, because some investors with a very long history of selling SPY may not want to trigger the capital gains tax on selling the position and thus choose to continue holding SPY rather than the alternatives with lower expense ratios. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. Despite TLT being fairly volatile and tying SPY for the second-highest volatility in the portfolio, it actually produces a negative risk contribution because it has a negative correlation with most of the portfolio. It is important to recognize that the “risk” on an investment needs to be considered in the context of the entire portfolio. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of TLT’s heavy negative correlation, it receives a weighting of 20% and as the core of the portfolio SPY was weighted as 50%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the S&P 500. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. Conclusion The nice thing about XLP is that has a correlation of only .84 with the S&P 500 and .47 with high yield bonds. For an aggressive portfolio, a small allocation to XLP can provide a nice reduction in risk. The beta on the fund is only .65 which reflects the combination of moderate correlation to the market and lower total volatility as demonstrated by 12% annualized volatility when SPY had 15.5% annualized volatility. When it comes to the expense ratio and the statistical factors, I think XLP is doing a fairly good job. However, I can’t get past thinking that a portfolio that adds some exposure to other addictive substances like alcohol would be creating a more resilient base for the portfolio. At the same time, I’d like to see a slightly larger volume of holdings (perhaps around 70 rather than 38) to reduce the idiosyncratic risk from holding larger positions in individual companies. XLP is a decent ETF and it performs well in a portfolio. However, I think it could be optimized a little better. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

Reaves Utility Income Fund: It’s Been A Tough Year

UTG is a well-regarded utility CEF. But that won’t protect you or it from losses in difficult markets. However, that doesn’t mean it isn’t a good fund. Reaves Utility Income Fund’s (NYSEMKT: UTG ) net asset value is down roughly 11.5% so far this year. That’s a rough showing, and investors have clearly been spooked, sending the market price of UTG down nearly 13% over the same span. That’s increased the discount of this well-respected fund, but not enough to scream buy… yet. What it does UTG is a utility fund, but takes a broad look at the space, including everything from the typical electric utility to telecom to oil to railroads. While utilities do make up around half the portfolio, the broader exposure means that UTG has more to offer on the diversification front. That can be a good thing, but also a bad thing — for example, owning oil and gas companies hasn’t been the best thing since the middle of 2014 when oil prices began to crumble. Still, Reaves has a long history of successfully navigating the various markets in which it invests. For example, over the trailing ten years through August, UTG’s annualized net asset value, or NAV, return is roughly 9%. That compares favorably to Vanguard Utilities ETF (NYSEARCA: VPU ), where the return was around 6.7%. Both numbers include reinvested distributions. And to UTG’s credit, its dividend has never included return of capital. It has always been made up of either income or capital gains. That said, capital gains have been a big piece of the puzzle in recent years, so a market downturn could make it harder for the CEF to maintain that streak. But if history is a guide, it will do whatever it can to keep return of capital to a minimum. The fund’s fees are a little high, with the expense ratio historically floating between around 1.5% and 2%. However that includes the interest costs associated with UTG’s use of leverage (it’s about 25% levered). The actual management fee has normally trended in the 1.2% area. That’s still high compared to an exchange traded fund like VPU, but not unreasonable for a closed-end fund. And for many investors, the added return will be more than worth the added expense. Yield is another place where UTG shines. While it’s nice that the fund has never dipped into capital to pay a distribution, the bigger number is that the yield is around 6.5%, paid monthly. That compares to VPU’s far less impressive yield of around 3.5%. Again, for the right investor, the added cost may be worth the added income benefit. And at 6.5% the yield isn’t so high that you have to fear a divided cut, which is a real risk for funds that yield 10% or more during a market downturn. So what’s going on now? But this year hasn’t been a good one for UTG. To be fair, that’s more a function of the market than the managers. UTG’s around 11.5% year-to-date NAV decline is roughly in line with the drop shareholders of VPU have experienced. In other words, Reaves Utility Income Fund is doing okay in a tough environment. However, spooked investors don’t usually care about things like that. They get scared and sell. So investor sentiment has been worse than performance, as shown by the nearly 13% drop in UTG’s market price. Which has left the fund’s discount to around 3%. That said, UTG isn’t a screaming buy. True, it is a good fund and anyone looking at the space should clearly be considering it. But the average discount over the past six months is around 4.7%, and the average over the past three years is around 4.7%. Based on its history, the discount is clearly still within a reasonable range. However, looking at the fund’s history a little closer, a discount in the 7% to 8% range is possible and would be a much better opportunity. This, however, doesn’t happen often. In fact, there are times when Reaves Utility Income Fund traded at a premium to its NAV. That’s not the norm for a closed-end fund. But Reaves has a great history, increasing the disbursement eight times since the fund started paying dividends in 2004 without a single distribution cut. And, as noted above, the distribution has never included return of capital. Add in the solid total returns and you can see that there’s a good reason why investors like the fund. Watch this one If you are looking for a diversified utility fund right now, you should consider UTG. It is truly a good fund that you should be comfortable owning for a long time. That said, if you are looking for a bargain, I don’t think UTG is there just yet. But with market volatility kicking up, keep a close eye on UTG, because fickle investors may just give you the opportunity to buy in on the “cheap.” Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.