PNM Resources: Priced Just Right

By | October 6, 2015

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Summary Management has made significant steps in past five years to improve profitability. Margins are up, energy generation mix is improving. Dividend has followed suit. Heavy interest expenses and overhang of the company’s large ageing coal plant concerns me. PNM Resources (NYSE: PNM ) is a holding company operating two regulated utilities, one in New Mexico and Texas. The company had a rough go of it from 2007-2011; exiting from non-regulated businesses at great cost focus on only serving regulated customers. Management may not have known what they were in for, as the next few years of regulatory environment were tough, with harsh allowed returns and strict oversight. PNM Resources was forced to heavily cut the dividend in between 2007 and 2009 as wholesale electricity prices plunged, chopping it nearly in half from $0.91/share to $0.50/share. The dividend remained stagnant at those depressed levels until a 2012 hike. This marked the start of a company revitalization as PNM Resources has bumped the dividend significantly, averaging 15% per year since then, as operating results recovered. Shares have responded to the flood of good news, rallying off lows near $10/share in 2010 to nearly $30/share today, recovering most of their losses from 2007-2010. Is there more upside for shares? Business Overview The company operates a diversified portfolio of over 2,500MW in generation capacity. Like many utilities, PNM is reducing its reliance on coal, instead shifting to natural gas. However, the largest generation facility for PNM Resources remains its San Juan Generating Station in Waterflow, New Mexico. This plant used to be much larger, but the company was forced to retire 900MW of capacity on regulator and environmentalist pressure – or face heavy capital expenditures related to mandatory upgrade costs. It is likely that this plant will continue to see aggressive treatment by regulators as coal continues its slow-and-steady decline as a source of power in the United States. Investors should expect continued power generation and compliance costs with the overhang of possible additional restrictions on aged coal-fired facilities like this one. PNM Resources expects to keep remaining capacity here online until at least 2022 given the recent contract extension with a local coal supplier for fueling needs. Operating Results (click to enlarge) While 2011 was a much bigger revenue year for 2011, that doesn’t tell the entire story. 2011 was a turning point year where many changes went into place at PNM Resources. The company exited its non-regulated businesses in Texas in 2011 ($329M in proceeds), using the proceeds to pay down debt and repurchase shares. This divesture followed the exiting of New Mexico Gas in 2008 as the company struggled to stay afloat, facing mounting losses in wholesale energy where the company simply couldn’t compete. Tough choices were made and SG&A expenses were cut as well as PNM Resources streamlined its operations. All told after a lot of work, all these changes have resulted in much better operating margins from 2012 forward. (click to enlarge) PNM Resources has run cash deficits as we can see from above, which has been paid for by more than $500M in net long term debt issuance since 2011. Like I feel with most mature utilities, I really want to see these numbers temper. Continued weakness here means no cash flow available for increased dividend payments without increasing leverage through long term debt or dilutive common stock issuance. Interest expense already eats 40% of operating income, well ahead of most other utility businesses I’ve looked at in the past. Conclusion At around 16x 2016 earnings estimates, shares aren’t the most expensive utility shares out there, but they don’t appear to be the cheapest either. The current dividend yield of 2.85% is in-line with historical averages. Management has guided towards 8% dividend growth, which I think is achievable assuming capital expenditures come down and demographic trends continue to be favorable in New Mexico and Texas. The heavy interest expense and lack of operational cash flow concern me. Shares are likely fairly valued at current prices, but investors who are looking to pick up shares of PNM Resources are best served by playing the waiting game and entering around $25.00/share, a spot where shares have tested and experienced solid support over the past year. Scalper1 News

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