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Should You Stick With Duke Energy After A Rough Year?

Duke Energy has received the first two regulatory approvals to proceed with its acquisition of Piedmont. The annual average residential electricity sales will drop 0.5% in 2016, but the prices increase will offset the impact of unfavorable weather conditions. Duke Energy is trading at very reasonable valuation and offers a very attractive dividend yield of 4.58% at current levels. Duke Energy (NYSE: DUK ) has received the first two regulatory approvals to proceed with its acquisition of Piedmont Natural Gas (NYSE: PNY ). Now the approval of Piedmont’s shareholders and permission from the N.C. Utilities Commission is required to complete the transaction. So far the process has progressed smoothly, and Piedmont’s shareholders will meet on January 22, for that purpose. Duke Energy will become the largest gas utility in the state and N.C. Utilities Commission could raise concern over the dominance position, but the management expects to complete the transaction on time. Duke Energy, like most of the other utility stocks, underperformed during 2015 primarily due to uncertainty over interest rate hike. Now finally, Fed has raised the rate and would continue to hike steadily during 2016. The only downside of interest rate increase for Duke Energy is that incremental financial burden could restrict the earnings growth. In this scenario, the investor might be concern over the sustainability of future dividend payments. However, consistently growing regulated electric & gas operations and stout cash flow position will enable Duke Energy to bear the shock and continue to return cash to shareholders. So far this year, Duke Energy has delivered satisfactory performance despite very rough weather conditions. In the coming quarters, the outlook of unregulated utilities is likely to remain challenging primarily due to declining power and natural gas prices and soft electricity demand. On the contrary, regulated utilities will benefit from the supportive regulatory environment, resulting in steady operating earnings growth in 2016. While overall sector earnings are likely to grow 3.7% during, Moody’s (NYSE: MCO ) expects that regulated utilities will witness better operating earnings growth. Source: Factset Duke Energy’s regulated utilities segment recorded operating revenue of $17.09 billion, an increase of only $16 million year-over-year. The flat top-line was due to unfavorable weather during the first half of 2015, but the segment revenue increased 2.7% during the third quarter on the back of mid-single digit increase in electricity demand. Currently, the regulated electricity business is 91.3% of total revenue flowed by 6.4% nonregulated and 2.3% regulated natural gas. Going forward, the addition of approximately $1.4 billion annual sales from Piedmont will significantly increase the revenue contribution of Duke Energy’s existing regulate natural gas business. In the advantageous scenario, the aggressive acquisition of regulated assets will fuel the company’s earnings. (click to enlarge) Source: Company Presentation The commercial and industrial demand is steadily rising, but the mild weather is negatively impacting the demand for residential electricity. The Energy Information Administration (EIA) estimates that annual average retail residential sales will drop 0.5% in 2016, but electricity sales to the commercial and industrial sector will increase by 0.7% and 1.4%, respectively. Source: EIA Duke Energy may continue to witness flat residential usage per customers owing to stable demand and improving efficiency level, but an increase of 0.7% in residential electricity prices will support the growth during 2016. Moreover, the diversified customer base and the addition of new residential customer at a low single-digit, the company added 1.3% new customer over the past twelve months, will boost the top-line at a steady pace. On the other hand, the potential ease in currency headwind and divestiture of poor performing assets could also improve the revenue from international operations. Thus, the trickling down of revenue growth, solid gross margins, and a massive $10 billion investment in gas & electric infrastructure will enable Duke Energy to accelerate an average long-term earnings growth of 4% – 6%. Duke Energy pland to invest approximately $20 billion in new generations and infrastructure development between 2015 and 2019. So far, the company has spent $4.64 billion in CAPEX during 2015, while it generated $5.4 billion in operating cash flow with cash & cash equivalent of $1.37 billion cash. The cash flow position looks pretty healthy, which depict that the company would be able to manage CAPEX and dividend payments without any cut if the interest rate increases further. Duke Energy increases dividends each year, and it has paid the quarterly dividend for 89 consecutive years. Duke Energy is one of the high yield utility stocks and currently, it offers a yield of 4.58%, significantly higher than the average 3.90% yield of large-cap electric utilities in the U.S. Duke Energy has increased the dividend at a CAGR of approximately 2% between 2009 and 2014. Now, the company has recently boosted the increase rate to 4%. The management expressed the intention to increase the future dividend more in line with the long-run earnings growth, which is 4% – 6%. Though interest rate is a threat, the healthy balance sheet will enable the company to maintain the dividend growth. Source: Finviz The balance sheet of the company is very sound with total assets of $121 billion. In contrast, the company has a total debt of $40.2 billion. The debt would increase in 2016 owing to partial debt financing to complete the acquisition and additional debt from Piedmont. Despite the substantial debt, the company’s financial health is likely to remain rigorous as it invests in quality assets to generate growing cash flows, and its total debt to asset ratio, excluding goodwill, is only 0.38 times. Currently, the total debt to equity ratio of Duke Energy is 1.07 times, which seems quite high but is significantly lower than the large-cap electric utilities average and median of 1.38 times and 1.21 times, respectively. Moreover, the interest coverage ratio of 3.85 times depicts that Duke Energy is in a very comfortable position to cover the future interest expense while raising the dividend in line with the earnings growth. Duke Energy delights the investors by raising dividends, which are backed by consistently growing earnings. Unfortunately, Duke Energy is one of the stocks to lose double-digit value during 2015 primarily due to interest rate turmoil throughout the year. On the flip side, Duke Energy is now trading at very reasonable valuation, and its yield has increased due to a steep decline in share price. Duke Energy is currently trading at forward PE of 15.31x, which is slightly less than the utility sector forward PE of 15.5x. That said, Duke Energy is a very decent utility stock to hold for growing dividends and investors should not worry about the interest rate as it is already priced-in.

Enhancing Performance With Low Volatility ETPs

One theme that I will spend more time on in 2016 and beyond is the low volatility anomaly, which has been discussed in considerable detail in the academic world, leading to papers such as the following: In a nutshell, the research supports the claim that low volatility and low beta stocks in the United States and across the globe outperform high volatility and high beta stocks, with low volatility stocks generating substantially higher risk-adjusted returns. Not coincidentally, the groundswell of research pointing to outperformance by low volatility stocks has created a land rush for low volatility ETPs in the first generation of “smart beta” or factor-based investment products in ETP wrappers. Since I believe smart beta or factor-based ETPs is one of the key revolutionary ideas to appear in the investment world in recent memory, I will have a great deal to say about this subject and the many tangential ideas that arise from it going forward. After nine years focusing primarily on the VIX, volatility and related subjects, it is time to charge off in some new directions, starting with some that have a whiff of volatility and ETP innovation. For now, I am going to be content with updating a February 2013 post, with the title The Options and Volatility ETPs Landscape . At that time, I wanted to capture those ETPs that employed a buy-write/covered call approach, employed a put-write strategy, focused on the convertible bond space or targeted low volatility stocks. Well, a lot has changed in the past three years, notably in the low volatility space. This time around, I have some enhancements to the options and volatility ETPs graphic. As is the case with The Current VIX ETP Landscape , I have added yellow stars for those ETPs with an average daily volume of 1,000,000 or higher and pink stars for ETPs with an average daily volume between 100,000 and 1,000,000. Additionally, I have highlighted the new currency-hedged crop of low volatility ETPs by using a red font and have captured the demise of HFIN, a financials buy-write ETF that closed in March 2015 with an X-HFIN designation. (click to enlarge) (source(s): VIX and More) There are a number of other sub-categorizations I will delve into at a future date, but note that whereas FTHI is a buy-write only, FTLB adds an out-of-the-money put. Three other relatively new arrivals, CFO , CDC and CSF , are structured so that they will hold up to 75% of portfolio assets in cash in adverse market conditions. Another intriguing new entrant, SLOW , attempts to avoid sector bias by forcing greater sector diversification than most other low volatility ETPs. So if you found 2015 volatility to be daunting and are looking to dampen volatility in your portfolio in 2016 or tap into the performance benefits of the low volatility anomaly, keep the list above in mind. While comprehensive and including many ETPs with marginal liquidity, this list may not touch upon some of the many new and illiquid products that might be flying under the radar.

A Year-End Analysis Of The Ark Industrial Innovation ETF

Summary The ARK Industrial Innovation ETF’s expense ratio of 0.95% coupled with the firm’s concentration on riskier holdings makes this an investment to avoid. The overvalued price to earnings ratio of the fund combined with the poor sales growth and historical earnings % makes this ETF unattractive. The leaders of the Ark Industrial Innovation ETF are Delphi Automotive and Nvidia Corp. The main laggard is Stratasys, Inc. In the comment section of my most recent analysis regarding the Robo-Stox Global Robotics and Automation Index ETF (NASDAQ: ROBO ), one person asked if there were any suitable ETF for an individual that craves exposure to robotics and automation. I gave a succinct answer with a mention of the Ark Industrial Innovation ETF (NYSEARCA: ARKQ ). While this ETF may be a bit more attractive than the ROBO-STOX Global Robotics and Automation Index ETF, it is not attractive enough to recommend as an investment. In mathematics, it is not merely sufficient to give the final answer. The math teacher will often insist that we show our work to support the final answer. Consider this article as my shown work. According to Yahoo Finance, here are the 1 month, 3 month, 6 month and YTD Returns for the Ark Industrial Innovation ETF. TIME PERIOD ARK INDUSTRIAL INNOVATION ETF RETURN ROBO-STOX Global Robotics and Automation Index ETF Return 1 MONTH 1.01% -1.16% 3 MONTH 9.15% 10.30% 6 MONTH -3.79% -9.31% YEAR-TO-DATE -1.13% -5.00% In comparison, the ROBO-STOX Global Robotics and Automation ETF only posted a higher 3-month return than the ARK Industrial Innovation ETF. Throughout this ETF, there is a whole lot of evidence that suggest that the fund manager may have invested in full of holdings that have unproven earnings and sales in spite of their overall potential. Evidence of this can be seen in the large percentage of mid-cap, small-cap holdings and micro-cap holdings that is displayed in the following chart. SIZE % OF PORTFOLIO BENCHMARK CATEGORY AVERAGE MEDIUM 30.65 18.63 23.79 SMALL 19.80 5.41 11.69 MICRO 13.15 0.32 1.39 The significant exposure to these riskier holdings seem more inconvenient when one considers the fund’s expense ratio. The ARK Industrial Innovation ETF’s expense ratio is 0.95%, which is 0.41% higher than the Morningstar category average . Investors may be willing to take on this exposure given a more attractive expense ratio. Unfortunately, this fund does not provide that. Value and Growth Measures Stock Portfolio Benchmark Category Average Price/Prospective Earnings Ratio 26.03 19.01 22.08 Price/Book 2.20 3.54 3.87 Price/Sales 2.30 2.61 2.74 Price/Cash Flow 16.77 11.69 11.49 Long-Term Earnings % 13.76 11.87 16.96 Historical Earnings % 3.96 9.38 15.18 Sales Growth 4.18 7.65 16.73 Cash Flow Growth % 16.86 9.82 12.78 If you look at the following chart, one can see that the statistics illustrate overvaluation of holdings with regards to stock price in the price/earnings ratio. One can also see that the fund holds many holdings with unproven sales and earnings as indicated by the fund’s undervalued price/sales ratio. This can also be seen by the paltry sales growth and historical earnings figures compared to their benchmarks and category averages. However, the fund does have a higher cash flow growth rate than the Morningstar benchmark and category average. This should provide some optimism for investors as increased cash flow could hopefully lead to a higher sales and net income in future earnings reports. LEADERS OF THE ARK INDUSTRIAL INNOVATION ETF Delphi Automotive PLC (NYSE: DLPH ) Delphi Automotive PLC is a manufacturer of vehicle components and provides solutions in terms of electrical, electronic, safety and thermal technologies to consumer and commercial vehicles worldwide. Delphi has the fourth highest portfolio weight in the fund at 4.67% and has a total YTD Return of 20.79%. Delphi’s last quarterly earnings report fell short of expectations. In spite of increased EPS and net income , Delphi’s revenue fell 3.6% year-over-year due to unfavorable currency impacts especially with regard to the euro. Delphi’s stock price fell more than 7% on the news but has rebounded by 8.5% since the date of the report. Delphi Automotive has just completed a $1.85 billion dollar acquisition of the HellermanTytonGroup PLC, a worldwide leader in cable management solutions. This acquisition will aid in the company’s effort to position themselves as a leader in the connected car phenomenon. It is expected to boost the firm’s potential EPS by $0.15 and provide 50 million dollars in synergies by the end of 2018. Delphi Automotive has just received an upgrade to “Buy” by Sterne Agee and is rated a “Buy” overall by analysts. Nvidia Corp (NASDAQ: NVDA ) Nvidia Corp is a visual computing company that operates across multiple regions. Nvidia Corp has the ninth highest portfolio weight at 3.41% and a YTD Return of 67.40%. NVIDIA’s stellar quarterly earnings sparked the firm’s stock price increase by 11.8% during the month of November. Nvidia’s revenue increased by 6.5% to a record revenue total of $1.305 billion dollars while its net income increased by 42% year-over-year to $246. Additionally, GAAP EPS increased 42% year-over-year to $0.44. NVIDIA made tremendous progress in its gaming segment with the introduction of the GEForce GTX 950 GPU. Additionally, NVIDIA made strides in the virtual reality space with the introduction of the NVIDIA Gameworks VR and NVIDIA Designworks VR. NVIDIA Corp has also gained firm control of the discrete graphics card market. At one point, the firm surpassed 80% in unit market share during its last fiscal quarter. The firm’s shareholders will be very thrilled with the firm’s 18% increase in quarterly cash dividend due in fiscal 2017. MAIN LAGGARD OF THE ARK INDUSTRIAL INNOVATION ETF Stratasys, Inc. (NASDAQ: SSYS ) It is rather puzzling why this stock has the most portfolio weight (6.71%) in the ARK Industrial Innovation ETF. As I have recently pointed out on Market Eyewitness , Stratasys is ripe for the picking due to increased competitiveness from the low end of the 3-D Printing market. Stratasys, Inc. has the second worst YTD return in the fund with a total of -67.77% Stratasys’s recent 6-K results were so poor that the firm would have had a net loss that was 6x as much as last year’s net loss in spite of the $695 million dollar impairment charge. Stratasys’s product revenue declined by 35.2% in the firm’s latest quarterly report. This is a clear sign that hobbyists and DIY enthusiasts have found other alternatives to the firm’s Makerbot division. In a recent list of the top 20 3-D desktop printers by 3-D Hubs, the Makerbot 3-D Printer did not made the cut. As a matter of fact, the two worst fund holdings in terms of YTD return are Stratasys, Inc. and 3D Systems (NYSE: DDD ). 3D Systems has an YTD Return of -68.06%. BOTTOM LINE: As stated above, I cannot recommend the Ark Industrial Innovation ETF as an investment even though it may be a better alternative than the Robo-Stox Global Robotics and Innovation ETF. In addition to the overvaluation in terms of the fund’s P/E ratio, the fund is too concentrated on riskier firms with an unproven history of sales and earnings. The lack of sales growth is disconcerting and the low price-to-book ratio may be indicative of investing in companies that may have fundamental deficiencies. Stratasys and 3D Systems could be considered Exhibit A and Exhibit B in that regard.