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Summary Electric utility IDACORP’s shares performed strongly in the second half of 2015 despite the Federal Reserve’s interest rate increase and a disappointing Q3 earnings report. The share price increase has come even as the company’s earnings estimates have remained stable, however, and its operating outlook has diminished. Snow pack levels in Idaho are currently well below long-term averages, and forecasts of reduced spring precipitation are unlikely to make up the difference. IDA’s shares are overvalued given the prospect of a fall in hydroelectric output at the same time as El Nino results in a hot early summer. Shares of Idaho electric utility IDACORP (NYSE: IDA ) have defied conventional wisdom over the last several months, setting a new all-time high last December despite announcement of the first U.S. interest rate increase in nearly a decade and persistent drought conditions in the company’s service area. In an article published in July, I recommended the company’s shares at the right price, highlighting its excellent earnings and dividend increase records. IDACORP’s share price proceeded to increase 20% by the end of the year, making it one of the market’s better performers as the S&P 500 lost a bit of ground over the same period (it has since lost some ground amidst wider market turmoil). Developments in the company’s service area are likely to impact its returns in 2016, however, and this article reevaluates IDACORP as a potential long investment opportunity. Q3 Earnings IDACORP reported Q3 earnings that, while disappointing compared to expectations, only caused a short pause in the ascent of its share price. The company reported revenue of $369.2 million, down 3.4% from the previous year as the presence of lower temperatures in late summer caused its total sales volume to decline. This was partially offset by a 1.8% increase to customer numbers as the service area’s economy continued to perform well. The company’s cost of revenue fell to $126.4 million from $141.5 million over the same period as energy prices continued to fall after rebounding during the previous quarter. Gross profit rose slightly as a result, from $240.7 million to $242.8 million YoY. Operating income fell slightly to $104.7 million despite this improvement. While customer growth provided $3.4 million in additional income, this was more than offset by a $9.4 million reduction resulting from reduced electricity demand in the service area. IDACORP’s Q3 net income came in at $73.3 million, down from $86.9 million YoY. Contributing to the negative impact of reduced electricity demand was a $11.1 million increase to the company’s income tax following a change to its tax accounting methodology. It should be noted that the company’s net income would have fallen by only 3% but for the one-time accounting change. As it was, the company reported a diluted EPS of $1.46, down from $1.73 YoY and missing the consensus analyst estimate by $0.08. Its EBITDA, which was the best indicator of Q3 performance due to its exclusion of tax costs, fared better, falling only slightly from $154.7 million to $152.9 million over the same period. IDA’s balance sheet remained strong at the end of Q3 for a utility, boasting a current ratio of 2.4x and an assets-to-liabilities ratio of 1.5x. While the company’s free cash flow fell during the quarter on a YoY basis, management felt comfortable enough with its performance to continue its dividend increase record by increasing the quarterly payout by 8.5% to $0.51/share. This decision was aided by management’s expectation that it will not be required to return any revenue to its customers in 2015 following weather-related demand weakness despite returning nearly $5 million in the previous year. Q4 and FY 2016 Outlook IDACORP’s management maintained its previous EPS guidance for FY 2015 of $3.75-3.90 despite the Q3 earnings miss, a decision likely influenced by the fact that the miss fell within the guidance range. Equally important was its announcement that it continues to expect to incur up to $310 million on capex in FY 2016, indicating that it does not expect to have any difficulties financing its operations despite the presence of higher interest rates. This expectation is reasonable given the continued strength of its balance sheet. In July, I discussed the presence of sustained drought conditions in IDACORP’s service area and the potential for this to negatively affect its operations, which rely heavily on hydropower for generating capacity. Management reduced its FY 2015 hydroelectric production estimate from 6-7 MWh in July to 5.7-6.2 MWh at the end of Q3 due to persistent dry conditions during the quarter. Reduced hydroelectric supply didn’t negatively impact the company’s FY 2015 guidance due to reduced cooling degree-days in its service area in late summer and the seasonal weakening of electricity demand in Q4. There is a higher probability that continued dry conditions in Idaho will negatively impact IDACORP’s earnings in 2016, however, especially as hot conditions return in Q2 and Q3. This year’s particularly strong El Nino event has resulted in lower-than-average winter precipitation levels in Idaho, with the company forecasting a 40-50% chance of drier-than-average conditions between November and January. While the forecast period has yet to end, the precipitation data suggests that this has indeed occurred. The snow pack in the areas surrounding the company’s hydroelectric capacity is currently 20-25% smaller than average, and in some areas, snow pack levels are currently on track to set record lows (although it should be noted that it normally doesn’t peak until mid-April). The snow pack will need to achieve 125% of its normal growth rate between now and April just to reach its average peak level. Such a result is increasingly unlikely to occur given that past El Nino event’s have been associated with reduced precipitation levels in Idaho over the same period. While Idaho’s snow pack levels are not yet expected to fall to the lows seen in California that have resulted in a sharp reduction in hydroelectric output, the state’s output is likely to fall even as electricity demand in IDACORP’s service area exceeds the long-term Q2 average. Previous El Nino events have also been associated with early summer temperatures that are well above average . Q3 has historically been a major contributor to the company’s annual earnings, generating 33% of its annual EPS over the TTM period, for example. A shortfall in hydroelectric output could force the company to utilize capacity with higher variable costs and, while a favorable regulatory scheme would mitigate the impact of such an increase on its bottom line, higher prices could also result in another reduction to sales volumes despite the presence of warm temperatures. One topic that I didn’t cover in my previous article was the Clean Power Plan, which the Obama administration rolled out last summer. The plan requires U.S. states to achieve predetermined reductions to the carbon intensities (i.e., greenhouse gas emissions per kilowatt-hour of electricity generated) of their electric utilities. While many Mountain West states are required to achieve large reductions under the plan, Idaho’s heavy reliance on zero-emission hydroelectric capacity means that it must achieve only a 10% reduction to its carbon intensity by 2030. Only 31% of the company’s generating capacity is coal-fired, with the rest being either zero-emission hydro or low-emission natural gas. IDACORP is unlikely to be impacted by the Clean Power Plan’s implementation as a result, especially in light of Idaho’s low burden under it. Conclusion Idaho electric utility IDACORP’s share price was a strong performer in the second half of 2015 as its robust balance sheet and advantageous operating location offset investor concerns about higher interest rates. Even a Q3 earnings result that missed the consensus estimate failed to daunt the company’s investors for more than a few weeks. This resilience has caused the company’s P/E ratio to continue rising, however, reaching 18x its FY 2016 earnings late last month before settling to 17x today. While it is tempting to encourage investors to view IDACORP as a port of safety during this time of market turmoil, I am concerned that an unusual set of weather conditions will begin to have a negative impact on the company’s earnings in 2016. While its heavy exposure to hydroelectric generating capacity will allow it to mostly avoid the terms of the Clean Power Plan that were laid out last August, this same exposure will also prove a challenge in Q2 if above-average temperatures resulting from El Nino combine with reduced snow pack levels to push generating costs higher. The company’s favorable regulatory environment will insulate it to a certain degree, of course, and I do expect its shares to continue to outperform the broader market in the short term should the current volatile trading environment persist. That said, IDACORP’s shares are very expensive at 18x its FY 2016 earnings estimate, and earnings growth does not seem likely at this time. I encourage potential investors to wait for a better buying opportunity before initiating a long position since the shares’ premium does not reflect the headwinds that the company is likely to encounter in the first half of 2016. Scalper1 News
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