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ITC Holdings To Join Utility Industry M&A Wave

ITC Holdings announces strategic review that includes a sale of company; stock soars 12.8%. We believe transaction is likely at $44-$47 per share, as strategic bidders National Grid, Iberdrola, and Berkshire Hathaway participate in competitive bidding. ITC Holdings is attractive target with $120-$160 billion capital investment opportunity, unique regulatory structure; Merger approval process may be shorter than other industry M&A deals. Shareholders in ITC Holdings (NYSE: ITC ), a leader in electric transmission in the US, saw its stock soar 12.8% from Friday’s close to $38.04 per share following an announcement that the board is reviewing its strategic options. The possibilities under consideration include a sale of the company, and we believe, for several reasons, that an outright sale of ITC Holdings to a strategic bidder is a highly probable outcome. We are currently in the middle of a significant M&A boom in the power and utility industry: Over $45.4 billion in deals were announced in the third quarter of 2015. This quarterly total exceeds the total transaction value of announced deals in the prior four quarters combined by over $7 billion ($38.3 billion in total from Q3 2014 to Q2 2015). Among the largest announced deals were the acquisition of Oncor Electric Delivery from the bankrupt Energy Future Holdings for $12.6 billion, Southern Company’s (NYSE: SO ) $12 billion acquisition of AGL Resources (NYSE: GAS ) ( as discussed here ), and the $10.4 billion acquisition of TECO Energy (NYSE: TE ) by Emera ( OTCPK:EMRAF ). (click to enlarge) Source: PwC report on Power and Utility Industry, October 2015. The recent wave in M&A activity in the regulated power industry is precipitated by a change in market dynamics from higher operating and maintenance costs and increased capital investment requirements. The costs of new utility construction and facility improvements continue to march upwards, as expense for labor and building materials rise. While allowed rate increases have been able to offset a considerable portion of these costs, rate increases for customers have been under pressure from a lower cost of capital in a low interest rate environment. With this underlying shift in the market taking place across the industry combined with stagnant demand for many utilities in their existing territories, several companies are looking beyond their own market to expand their customer base and generate economies of scale through operating efficiencies. These factors have served as the catalyst for several strategic acquisitions over the past twelve months including the larger deals announced in the third quarter as well as transactions as Exelon’s (NYSE: EXC ) $6.8 billion purchase of Pepco Holdings (NYSE: POM ). We anticipate that these industry factors will continue to drive consolidation and M&A activity is likely to remain robust through 2016. (click to enlarge) Source: ITC Holdings investor presentation, Edison Electric Institute 50th financial conference, November 8, 2015. With this industry backdrop, we believe the Board of ITC Holdings is making a shareholder-friendly decision in reviewing all of its strategic alternatives at this time and the Board appears to be taking the first steps in fulfilling its obligation to pursue value-enhancing action when the opportunity arises. Over the past three months, ITC Holdings’ stock has traded in the $31-$33 per share range and as much as 31% below its 52-week high trading price of $44 per share. This underperformance is very discouraging for long-term shareholders and many patient investors may be ready to cash out of their holdings at the right price. (click to enlarge) Source: ITC Holdings investor presentation, Edison Electric Institute 50th financial conference, November 8, 2015. It is our view that putting the company up for sale now would deliver the greatest value for ITC Holding shareholders. We believe that a sale of ITC Holdings would result in an all-cash transaction with consideration worth between $39 to $47 per share. Our valuation is based on a PE multiple of 18.5x to 22.5x on projected 2016 earnings per share of $2.10. This PE multiple range is consistent with multiples seen on recent transactions in the regulated power industry. Furthermore, the typical premium over the unaffected stock price we have seen is 20% to 40% which would imply a transaction value of $39 to $45 per share. In our view, the high end of these ranges would represent tremendous value for shareholders and exceed the all-time high trading price for ITC Holdings. From the standpoint of the strategic bidders believed to be interested in ITC Holdings, there are many compelling reasons to acquire the company and pay top dollar. One of the most attractive aspects of ITC Holdings is the significant future infrastructure requirements. Management estimates an investment in upgrades of $120 – $160 billion will be required through 2030 driven by an aging infrastructure and regulatory and compliance investments. The opportunity to put well over a hundred billion in capital to work and earn a decent return on the invested capital for the foreseeable future will appeal to the larger strategic acquirers such as National Grid (NYSE: NGG ), Iberdrola ( OTCPK:IBDSF , OTCPK:IBDRY ), Berkshire Hathaway ( BRK.A , BRK.B ) Energy, and NextEra Energy (NYSE: NEE ). Additionally, the unique regulatory structure that ITC Holdings is subject to is a very attractive characteristic of the company and provides ITC Holdings with an advantage over other potential acquisition targets in the regulated power industry. ITC Holdings is regulated at the federal level by the Federal Energy Regulatory Commission and the agency acts in setting the rates for the company’s vast electric transmission assets that span the U.S. Midwest. As a result of this regulatory structure, the regulated return on equity for ITC Holdings has consistently exceeded that of its state-regulated peers by as much as 200 basis points. We believe there is also a transaction-specific benefit of the unique regulatory structure The downside risk for ITC Holdings shareholders (and any shareholder of a utility company that is acquired) is the complex regulatory approval process of an acquisition. The unpredictable and often politically-charged process has delayed some transactions for several months. The average length from announcement to completion of an acquisition in the power and utilities industry is nearly 8 months between 2009 and 2013. As many investors in recent M&A deals will attest, the figures for 2014 and through the third quarter of 2015 are likely higher. For example, the proposed Exelon-Pepco transaction has been pending for over 19 months and may finally be approved as we approach the two-year anniversary of the April 2014 acquisition announcement. (click to enlarge) Source: Deloitte Center for Energy Solutions. Understandably, this burdensome process may deter a potential acquirer from pursuing a negotiated agreement. However, for ITC Holdings, we do not believe this will hold true. In our view, a proposed transaction may not have to receive the approval of each state jurisdiction in which ITC Holdings’ electric transmission subsidiaries operate. We believe approval of the Federal Energy Regulatory Commission and the Federal Antitrust authorities would satisfy the company’s statutory requirements. According to ITC Holdings’ most recent 10-K filing, state regulators’ authority and scope of oversight is quite limited: “The regulatory agencies in the states where our Regulated Operating Subsidiaries’ assets are located do not have jurisdiction over rates or terms and conditions of service. However, they typically have jurisdiction over siting of transmission facilities and related matters as described below. Additionally, we are subject to the regulatory oversight of various state environmental quality departments for compliance with any state environmental standards and regulations.” In our view, the FERC will have jurisdiction, from a power and utility industry standpoint, over the approval of any proposed transaction and would make the determination of the competitive effects of a merger and the long-term impact on the ratepayers. While the state jurisdictions may be involved in a regulatory review, we do not expect a state agency within the power industry to be in a position to make a binding decision as to the competitive effects of a proposed transaction. This unique regulatory structure therefore avoids a potential “DC Public Service Commission”-type disruption to a merger approval process where a small, activist group minimally impacted by a large multi-jurisdictional merger has the ability to delay the process or extract additional financial benefits from the parties. In conclusion, we believe a sale of ITC Holdings in the range of $39-$47 per share is in the best interests of shareholders and is a very likely outcome of the Board’s current strategic review. Based on the attractive characteristics and prospects of ITC Holding, we believe there will be active and competitive bidding by large strategic players in the regulated power industry and the results will be a final transaction price in the $44-$47 per share range. As such, we expect the power and utility industry consolidation will show no signs of slowing in 2016. And importantly, in contrast to several of the current prolonged transactions, we believe a proposed acquisition involving ITC Holdings will navigate the complex regulatory process successfully and in a more appropriate timeframe. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Concentration: The Age-Old Question

Summary I’ve made the case for concentration before, and while I still advocate concentration, my original “time” argument was misplaced because of diminishing marginal returns on time. Concentration is largely a function of risk tolerance, which makes it far easier to find an appropriate level for an individual investor than it is for a professional. There is a lot of value in thinking about position sizing in terms of “starter” and “core” positions. Concentration is a subject I’ve written on before. In one of my first SA articles , I made the radical argument for a form of hyper-concentrated investing termed “Focus Investing” whereby one holds 3-10 positions… or even just one. Concentration is still a topic I give an inordinate amount of thought too and I wanted to share some of those thoughts here. This post also follows my first post on stock screening in a series communicating my investment process and philosophy. On Time My thoughts on position sizing have definitely evolved since my first article, and in hindsight, some of my arguments, while nice in theory, don’t hold in reality and my use of them demonstrated my inexperience as an investor. For example: Time The responsible investor follows each and every one of his holdings. It takes a constant amount of time per week to stay up on a company. I would advise at least an hour per week. Again this time is constant, whether that company makes up 2% of your portfolio or 100%… He could own 10 companies and still diligently follow them, but he’d have to devote ten hours instead of one. But wait, if he was willing to devote 10 hours total to stock market research when he held 10 companies, why not spend the same time researching, but while only holding one company? He could spend 5 hours per week keeping up on Apple and another 5 researching potential investments, comparing them against Apple, only considering them if they seemed much more attractive. My argument that investments require a constant amount of time and that 50% of an investor’s research time spent on a single investment is a good strategy ignores one very important principle: diminishing marginal returns or, more practically, the 80/20 rule. See one of my favorite Seeking Alpha articles , which discusses this subject, before continuing. The first hour of research yields more information and more valuable information than the 100th hour. The other problem with the time argument is sunk costs. We all know that a sunk cost should not influence decisions, but that they often do and, sadly, this is true even for decisions that we (the same people who are aware of the phenomenon) make. When you spend weeks researching a company and preparing an extensive, tidy investment thesis and article on the stock, it’s just harder not to take a position, independent of the actual prospects of the investment. While my time argument was somewhat off the mark (though it does hold in extreme cases; time is a serious problem for an actively managed portfolio of hundreds of stocks), I’ve still been a proponent of concentration, to a lesser extent, recently. Professional Constraints Concentration is largely a function of risk tolerance. This is not that meaningful if you are only managing your own money. All it means is that you must discover your risk tolerance and volatility tolerance and find a commensurate concentration level. Thing get tricky, however, when you are managing money for others. Introducing clients means more than one brain and in turn, risk tolerance is involved. What is the appropriate level now? If you are a manager like me with one strategy and one portfolio, then you should stick to the concentration level that you think is best for total returns, but I don’t think the story ends there. There needs to be some consideration that you are a professional and are managing other people’s money. There is a higher standard. This is one good reason to find like-minded clients. If you can withstand volatility, are long-term oriented, and are okay with concentration, look for clients with the same approach. Good luck- they’re rare! My other insight is that adopting a concentrated strategy as a new manager is tough because it requires credibility, to some extent, to be very concentrated. The base rate in investing is market returns and those are derived from a market portfolio, which is very diversified (500 stocks if we assume S&P 500 = market). Naturally, the more concentrated your portfolio gets, the more different it gets from the market and the further from the base rate its returns. You are going further out on a limb. It’s tough to do that with no professional track record. The logical next step is that if you’re a new manager you should be very diversified, but that’s a dangerous path I don’t want to take because it eliminates my positive optionality of earning extremely good returns and I’m in the investing industry for more than just money. Intellectual stimulation and an interesting, meaningful career is the most important thing I seek and the use of money as a means of keeping score and creating value is a big part of the financial aspect. In short, if I’m to succeed, I want to do so on my own terms and that rules out heavy diversification. If that means a slower ramp for my firm, so be it. “Starter” and “Core” I’m at a point now where my view on concentration is somewhat nuanced. Because I employ both deep research and empirical, systematic methods in my portfolio, not all positions will be sized equally – far from it. Right now, I have some positions that are 15-20% of my portfolio and some that are less than 1%. I think this dual concept of “starter” and “core” positions has been very helpful and is worth discussing. For me a starter position is 1% and a core position is much more than that, but the numbers don’t matter as much as the way of thinking about position sizing it represents. A starter position represents something that should, based on empirical evidence, outperform. That is a firm requirement. I talked about this extensively in a previous post . A starter position is also something I’ve done some research on, find interesting, and can model a good expected return with little to no downside on in an adverse case. But for some reason, it’s not fit to be a core position yet. The most common reasons are: I’m not sure I understand it, i.e. it may not be within my circle of competence The expected return I model is not high enough to exceed my absolute return hurdle, i.e. it’s not quite juicy enough I’ve not done enough research or thinking yet, i.e. I need more time Starter positions are crucial to my investment process because they allow me to slow down. Doing research needs to be a treasure hunt for me. I’m only interested in learning about companies when there is the possibility of it being in my portfolio and making me and my clients money. During the research process, it’s so tempting to act on research and invest. It’s hard to delay gratification. The problem is that good long-term investment decisions are made slowly. Gratification must be delayed. However, I’ve found that taking a small starter position up front helps to hold me over. Of course, I don’t do this for everything I research, but obviously far more than I end up taking core positions in as the chart above shows. It also provides an extra incentive to continue to dig deeper in the research. As Tom Gaynor says : When I buy some of something, I’m buying a library card. One of the reasons I buy some of something is to make myself think more deeply about it, read the reports and be more aware of it. It’s hard to overstate the positive impact starter positions have had for me. Not only have they performed well in aggregate, which is how I look at their performance, but they’ve rejuvenated me as an analyst. There was a rough patch where I only published four articles and made four investment decisions, not all of which were good ones, over a period of almost 8 months. (click to enlarge) I researched more than just four companies over this period, but not at as high a rate as I am now and not as effectively. The lack of gratification in the research process demotivated me. There’s no rule saying research needs to be fun for you to be a good investor, but for me I think it does need to be or I won’t find anything to invest in. It needs to be a treasure hunt and starter positions help a lot on that front. At the same time, when my research does, on rare occasions, generate what I think is a really good idea, I’m not going to only put 1% in it. There are times when the level of conviction and opportunity costs make anything but a big position a bad decision and that is when I am willing to take a core position. That is where concentration is needed. And in aggregate, you still end up with a pretty concentrated portfolio. More than half of my portfolio is in 6 stocks despite the large cash position. So I still advocate concentration, but clearly have a more nuanced view now and recognize that position sizing is a far more difficult issue than I initially had thought.

Dividend Growth Stock Overview: New Jersey Resources Corporation

Summary New Jersey Resources provides natural gas services to over 500,000 customers in northern and central New Jersey. The company also has a growing wind and solar energy portfolio, currently totaling 147 MW of capacity. Over the last decade, the company has met its goal of compounding its dividend by 6-8% a year; the annual dividend growth rate has averaged 7.3%. New Jersey Resources has grown its dividend since 1995. The stock currently yields 3.2%. Among the areas that New Jersey Resources serves is the Jersey shore. Photo: New Jersey Resources Corporation’s 2014 Annual Report About New Jersey Resources Corporation New Jersey Resources Corporation (NYSE: NJR ) is an energy services holding company, whose primary business is the sale and distribution of natural gas to over 500,000 customers in the northern and central New Jersey. The company was formed in the early 1980s through the 1-for-1 exchange of New Jersey Natural Gas shares into the new holding corporation. In addition to the regulated natural gas business, New Jersey Resources offers other energy services to its customers and invests in midstream assets. The company’s operating area has a population of roughly 1.5 million people. (Note that one customer account usually serves more than one individual.) The company’s has four reporting business segments, which are organized roughly around its subsidiaries. The New Jersey Natural Gas Company subsidiary runs the natural gas distribution business segment, which is responsible for the regulated part of New Jersey Resources’ business: The distribution and sale of natural gas to retail customers. The Energy Services segment primarily consists of NJR Energy Services Company and is responsible for New Jersey Resources’ unregulated wholesale energy operations. The segment is also responsible for providing wholesale energy operations to other natural gas companies and energy producers. The Clean Energy Ventures segment is run by NJR Clean Energy Venture Corporation. This segment is responsible for investments in solar and onshore wind investments. This segment has a clean energy portfolio of more than 147 MW in electrical generation capacity. Finally, the Midstream segment is responsible for all of New Jersey Resources’ investments in natural gas transportation and storage facilities. NJR reports “net financial earnings” (NFE) as its primary profitability metric. NFE is the company’s earnings adjusted for commodity derivative and hedging contracts. For the 2015 fiscal year (which ended September 30, 2015), although New Jersey Resources earned $2.12 per share under generally accepted accounting principles, which was up 25% from 2014, NFE per share was $1.78, down 15.2% from 2014. New Jersey Resources seeks to increase NFE per share by 5-9% a year and the dividend 6-8% a year long term. With the current dividend of 96 cents, the payout ratio is 54%, below the company’s target range of 60-65%. Accounting for the company’s guidance of 2016 NFE per share of $1.55-$1.65, next year’s expected payout ratio is roughly 60%, before any increase. New Jersey Resources has an active share repurchase program and has repurchased 16.8 million shares since September 1996. In FY 2015, the company repurchased 348,200 shares. 2.7 million shares remain on the existing authorization, which represents 3.15% of the outstanding stock. The company is a member of the S&P 600 Small Cap and Russell 2000 indices and trades under the ticker symbol NJR. New Jersey Resources’ Dividend and Stock Split History (click to enlarge) New Jersey Resources has grown its dividend at 7.3% over the last 10 years. New Jersey Resources has paid dividends since at least 1988 and increased them since 1995. The company announces annual dividend increases in early-to-mid September, with the stock going ex-dividend about two weeks later. In September 2015, New Jersey Resources announced a 6.7% dividend increase to an annualized rate of 96 cents a share. The company should announce its 22nd consecutive annual dividend increase in September 2016. As noted above, New Jersey Resources aims to increase dividends by 6-8% a year, and targets a payout ratio of between 60% and 65%. The company has met its dividend growth target over the last decade – the 5-year and 10-year dividend growth rates are 6.15% and 7.29%. Over the last 20 years, the company has fallen short of the goal, with the dividend compounded at 5.16% annually. New Jersey Resources has split its stock three times since beginning its record of annual dividend increases. The company split its stock 3-for-2 in March 2002 and March 2008. Most recently, the company split its stock 2-for-1 in March 2015. Over the 5 years ending on June 30, 2015, New Jersey Resources’ stock appreciated at an annualized rate of 13.4%, from a split-adjusted $14.58 to $27.31. This underperformed the 15.0% compounded return of the S&P 500 index, the 17.2% return of the S&P Small Cap 600 index and the 15.7% return of the Russell 2000 index over the same period. New Jersey Resources’ Direct Purchase and Dividend Reinvestment Plans New Jersey Resources has both direct purchase and dividend reinvestment plans. You don’t need to be a current shareholder to participate in the plans – you can make your initial purchase in the plan. The minimum investment for the initial direct purchase is $100 and $25 for follow-on direct purchases. The dividend reinvestment plan allows for full or partial reinvestment of dividends. The company occasionally offers shares at up to a 3% discount through the direct purchase plan. The plan’s fee structures are favorable for investors. The company picks up the costs of buying shares through the both the direct purchase and dividend reinvestment plans. The only fees you pay through the plans are when you sell your shares. You’ll pay a commission of between $15 and $30, depending on the type of sell order, plus a transaction fee of 10 cents per share. You’ll also pay $5 to have the proceeds (net of any fees) directly deposited to your account. Helpful Links New Jersey Resources Corporation’s Investor Relations Website Current quote and financial summary for New Jersey Resources Corporation ( finviz.com ) Information on the direct purchase and dividend reinvestment plans for New Jersey Resources Corporation