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Summary I’ve written about several utility companies lately. They varied in growth and dividend yield. In one article, I said Southern Company should be avoided at the moment. In this article, I will write about investing in CenterPoint Energy, which I believe is a superior high yield, low growth utility. Introduction As I’ve written in several of my articles, I usually divide my dividend growth stocks in two ways. The first is by sector, which helps me diversify my portfolio. The second is by the state of the company. I then divide the companies into three types. The first is companies with low yield and high growth, the second is medium yield and medium growth, and the third is high yield and low growth. Sometimes you can find some bargains and get a high growth company for medium or even high yield, but usually the market knows how to price stocks. I’ve written about several utilities lately. These utilities were divided between these three groups. I wrote about ITC holdings (NYSE: ITC ) which has low yield and high growth; Wisconsin Energy (NYSE: WEC ) — my personal favorite — which has medium growth and medium yield; and Southern Company (NYSE: SO ), which has high yield and low growth. I also wrote in March about Avista (NYSE: AVA ), which also shows medium growth and medium yield. Retirees and older people look for the current yield, and therefore agree to accept the extremely low growth shown by some companies. In this article, I will analyze CenterPoint Energy (NYSE: CNP ), a company that has a higher yield than Southern Company and similar low growth. In my opinion, this company is more suitable for investors looking for current income. CenterPoint Energy is a public utility holding company. Through its subsidiaries it is engaged in the following business segments: Electric Transmission & Distribution, Natural Gas Distribution, Competitive Natural Gas Sales and Services and Other Operations. Fundamentals When I look at the past decade, CNP’s fundamentals seem pretty strong. However, as I will show here, they are not going to grow at the same pace in the future. For example, revenue actually declined from $9.7 billion in 2005 to $9.2 billion in 2014. This is an annual decline of 0.5% for the past decade. In the near future, both the company and analysts covering it believe that revenue will grow due to rate relief from the regulators as well as the growing number of customers. CNP Revenue (Annual) data by YCharts On the other hand, EPS has managed to show some significant growth. EPS grew from $0.75 in 2005 to $1.42 in 2014, which is a CAGR of over 6.5%. This is a decent number for a utility. However, the EPS for 2015 and 2016 will be much lower. The estimates for 2015 are between $1.05 and $1.1, and the company has reaffirmed its guidance for 4%-6% annual growth in EPS for 2015-2016. Basically we have a company that will probably show modest growth in both revenue and EPS for the next 3-5 years. CNP EPS Diluted (Annual) data by YCharts The dividend is probably the biggest reason to purchase this stock, as the EPS will grow slowly. The dividend has been raised every year over the past decade, and it grew from $0.38 in 2005 to $0.96 in 2014. This is a CAGR of almost 10%, which is much higher than the EPS growth. Due to that fact, the current payout ratio is 70% for the 2014 earnings, and over 90% for the mid point of the 2015 EPS guidance. Therefore, I believe that the future growth will be limited to less than the EPS growth, and I believe it will be in the range of 2.5%-4%. However, as the company is a utility, which is a regulated monopoly, the dividend is still sustainable. The current yield is really robust at 5.8%. CNP Dividend data by YCharts When I look at the fundamentals, I find that the growth will be slower in the future, but the yield is high enough to compensate income-oriented investors. I find it more attractive than Southern Company as the yield is higher, but the growth estimates are not lower. Valuation Valuation at the current price is pretty compelling, especially when compared to its peers. Due to the low growth, the company trades for a lower P/E than Wisconsin Energy or Avista. Their premium is explained by the higher growth. Currently, CNP trades for a P/E ratio of 15.62 for 2016, and 15.19 for 2017. This valuation is fair for a slowly growing company. CNP P/E Ratio (Forward 1y) data by YCharts In these two graphs, I compared the P/E ratio of CNP to the P/E ratio of SO. I made this comparison because both are diversified utilities that work in the southern part of the U.S. Both have high yield and low dividend growth going into the future. CNP has a much higher yield, and still the P/E is almost the same. I believe it is more attractive than Southern Company. Opportunities Regulation of utility companies can be an opportunity or a risk. At the moment, CNP states that current regulations are favorable to its ability to generate profits. In addition, in the past several months the company has asked for rate relief in a number of states, and regulators granted many of them. In the table below, you can see some of the granted requests. Some are still under examination by regulators, and will be determined shortly. This relief allows the company to increase its revenue and margins. The rate relief accounts for almost $300 million annually, and I believe it alone can push up revenue by 2% before inflation. This way, we can achieve growth of 3%-4% just by increasing the prices annually, and over 50% of it will come from the rate relief. Together with cost cutting efforts, the rate relief will not only increase revenues, but also profit margins and EPS. The goal is to reach double-digit profit margins, and it will take more price increases, as the current profit margin is almost zero. Another opportunity the company’s business segment and geographic diversification. It operates in several states, which means it has no exposure to a single regulator, diminishing its regulatory risk and giving it an advantage over its peers in that regard. Its revenues are divided equally between three segments: electric transmission, gas distribution and energy services. In addition, the company is a major holder of Enable Midstream Partners (NYSE: ENBL ), a joint venture with two of its peers — GE Energy and ArcLight Capital Partners. The entity is considered an MLP. It’s relatively not leveraged and has several growth prospects. It is a great opportunity for CNP to keep growing. When energy prices recover, MLPs’ prices will rise along with their profitability. This offers potential upside for CNP investors as an energy recovery play. When I said that Wisconsin Energy is a better investment than Southern Company, I was told to look at the area where the companies operate. WEC is in the rust belt, while SO is in the growing south. CNP operates mainly in the growing south, just like SO. Its primary customers are in the area around Houston, Texas, and the company dedicated an entire slide in its Q3 presentation to show that it operates in a quickly growing area. This gives CNP the ability to grow organically in the future. Houston is a huge opportunity for many reasons. First, it is one of the fastest-growing cities in the U.S., according to Forbes. Moreover, according to the Texas State Demographer, Houston’s population is set to keep growing in the next 35 years, mainly due to immigration. Houston is a great opportunity, as it is much more than the center of energy companies it used to be. Over 1500 corporations have relocated to Houston over the last 5 years, and it is becoming a base for medical companies and financial companies as well. All of these people and businesses will need both electricity and gas, and CNP will supply it. Risks The company still presents risks for investors. The first is its balance sheet. CNP is using a lot of debt. I believe that the debt load is manageable, and the company is aware of the associated risk. However, imminent interest rate hikes will make this debt more expensive. I must add that although any rise in interest rates is forecast to be slow, at CNP’s current debt to equity ratio, which is higher than 2, its fragile A1 credit rating may still be in jeopardy. CNP’s cash on hand decreased by almost 30% this year, and the credit rating agencies warned that its narrowing liquidity puts its credit rating at risk. When interest rates rise, more expensive debt may put this leveraged company in a very uncomfortable position, which will force it to cut the dividend. The company should maintain more than $100 million in cash, and it currently has around $225 million. The company is forecast to show very modest EPS growth in the medium term. This can easily mean a dividend freeze, and at the current dividend payout ratio, it will be very hard for the company to raise its distribution. In addition, the favorable regulatory environment mentioned above can always change. One regulatory change by a major state or by the federal government can result in damage to CNP’s income. With a payout ratio of 92%, that may cause a dividend cut. However, this risk is not too great, as the southern states where CNP operates tend to have favorable regulation for enterprises. The company should be very cautious in the short term to make sure that its dividend is sustainable. The combination of the growing dividend with rising interest rates and the current payout ratio could become a problem if management isn’t careful. The company does not produce electricity. It allows the producers to use its infrastructure to deliver electricity to its customers. These companies can create their own transmission network or use a competitor’s transmission network if they feel CNP’s prices are too high. However, this risk is mitigated by the fact the infrastructure request a lot of capital invested, which gives CNP a bit of a moat. Conclusion CNP is currently a solid business. It has almost no room for error in the medium term, but can still offer a better income than its peers. Of course, a dividend freeze is a very real concern if the company cannot grow EPS at the pace of the guidance. However, the MLP business can offer interesting upside in the future. At 25 years old, an investment that grows pretty slowly is not for me. I try to look for dividend growth stocks that can show medium to high growth, even if it comes at the expense of current income. Retirees and older investors should consider CNP, however, as its 5.8% yield is quite attractive for current income seekers. Scalper1 News
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