Tag Archives: debt

Southern Company – Rising Infrastructure Assets But Look Out For Some Challenging Quarters

Summary Southern Company is one of the largest utilities in America. Will grow to #2 spot by customer count after the AGL Resources purchase. Southern announced its plan to acquire AGL Resources for $8B cash – fueled by debt and equity issuance. The company is a dividend contender having raised dividends for 15 consecutive years; 5-yr dividend CAGR is 3.7% and Chowder Rule is 8.56. The Southern Company (NYSE: SO ) is one of the largest utilities company in America. The company serves more than 4.4 million customers and has approximately 46,000 megawatts of generating capacity serving the Southeast through its subsidiaries. Subsidiaries include electric utilities in four states – Alabama Power, Georgia Power, Gulf Power, and Mississippi Power; a growing, competitive generation company – Southern Power; a licensed operator of three nuclear generating plants – Southern Nuclear; and fiber optics and wireless communications – Southern Telecom and SouthernLINC Wireless, respectively. (Source: September 2015 Southern Company Overview Presentation ) In August 2015, Southern Company announced that it will be acquiring AGL Resources Inc. (NYSE: GAS ) in an $8B cash deal. This combined company will shift Southern from being an electric-only utility company to an electric-and-gas utility company. The customer base is expected to double with this move and pushes Southern to become the second largest utility company in America (by customer count), if the deal is approved. Corporate Profile (from Yahoo Finance) The Southern Company, together with its subsidiaries, operates as a public electric utility company. It is involved in the generation, transmission, and distribution of electricity through coal, nuclear, oil and gas, and hydro resources in the states of Alabama, Georgia, Florida, and Mississippi. The company also constructs, acquires, owns, and manages generation assets, including renewable energy projects. As of December 31, 2014, it operated 33 hydroelectric generating stations, 33 fossil fuel generating stations, 3 nuclear generating stations, 13 combined cycle/cogeneration stations, 9 solar facilities, 1 biomass facility, and 1 landfill gas facility. The company also provides digital wireless communications services with various communication options, including push to talk, cellular service, text messaging, wireless Internet access, and wireless data; and wholesale fiber optic solutions to telecommunication providers in the Southeast. The Southern Company was founded in 1945 and is headquartered in Atlanta, Georgia. A Closer Look The Southern Company has remained focused as an electric utility company through the years. The company has remained a heavy user of dirty fuels such as coal (accounts up to 42%) for its power generation over the years, but has started transitioning to cleaner resources including natural gas, solar and wind. This move will also be welcomed as the company aligns itself with the US government mandate targeting power plants to cut carbon emissions by 32% (by 2030) on the 2005 levels. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) Acquisition of AGL Resources Inc. In August 2015, Southern Company announced a plan to acquire AGL Resources Inc. for about $8B in cash, fortifying SO’s assets with the natural gas infrastructure. AGL Resources distributes gas in Georgia, Illinois, Virginia, New Jersey, Florida, Tennessee and Maryland. Southern Co. owns utilities in Georgia, Alabama, Florida and Mississippi. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) This move lowers SO’s dependence on power generation and pushes SO to the #2 spot in the utility sector by customer count after Exelon Corp. (NYSE: EXC ). The combined company will operate 200,000 miles of electric lines and 80,000 miles of gas pipelines. The deal is expected to close in the second half of 2016. Southern Company will be issuing $3B in new stock and also tapping into the debt markets to finance the merger. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) The deal is expected to raise the long-term EPS growth rates by 4-5%. In addition, the dividend growth is expected to rise faster than current rates. Dividend Stock Analysis Financials Expected: A growing revenue, earnings per share and free cash flow year over year looking at a 10-year trend. A manageable amount of debt that can be serviced without affecting future operations. (click to enlarge) (Source: Created by author. Data from Morningstar) (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The utility industry is resilient and has seen a slow and steady rise over the years. Revenues and earnings are fairly constant with year-over-year growth ranging between -0.3% to +0.15%. The debt load is also stable and SO enjoys a ‘A-‘ credit rating from S&P. SO has a debt/equity of 1.36 and a current ratio of 0.80. Those numbers can be expected to change significantly over the course of next year or two as the AGL purchase moves closer to closing. Dividends and Payout Ratios Expected: A growing dividend outpacing inflation rates, with a dividend rate not too high (which might signal an upcoming cut). Low/Manageable payout ratio to indicate that the dividends can be raised comfortably in the future. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: Utility companies are slow and steady growers and are perfectly suited for long-term dividend investors. Southern Company is a Dividend Contender having raised dividends consecutively for 15 years. The 1-, 3-, 5-, and 10-year dividend CAGRs are 3.5%, 3.6%, 3.7%, and 39% respectively. Coupled with a current dividend yield of 4.86%, SO has a Chowder Rule number of 8.56. The current payout ratio is 89%. Outstanding Shares Expected: Either constant or decreasing number of outstanding shares. An increase in share count might signal that the company is diluting its ownership and running into financial trouble. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The number of shares have risen steadily over the years and are expected to rise more as the company intends to issue $3B of new equity to finance the AGL deal – approx 66M new shares based on current price, an increase in the number of outstanding shares by ~7%. Book Value and Book Value Growth Expected: Growing book value per share. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The book value is a bright spot in the company’s financials. The book value has steadily increased over the years maintaining a nice upward trajectory, although we can expect this to stumble when more debt and shares are issued in the coming years. Valuation To determine the valuation, I use the Graham Number, average price-to-earnings, average yield, average price-to-sales, and discounted cash flow. For details on the methodology, click here . The Graham Number for SO with a book value per share of $22.22 and TTM EPS of $2.35 is $34.28. Based on the last closing price, the stock is currently 30% overvalued. SO’s 5-year average P/E is 18.92, and the 10-year average P/E is 17.80. Based on the analyst earnings estimate of $2.94, we get a fair value of $55.62 (based on the 5-year average) and $52.33 (based on the 10-year average). SO’s average yield over the past five years was 4.60% and over the past 10 years was 4.61%. Based on the current annual payout of $2.17, that gives us a fair value of $47.17 and $47.07 over the 5- and 10-year periods, respectively. The average 5-year P/S is 2.16 and average 10-year P/S is 2.0. Revenue estimates for next year stand at $21.18 per share, giving a fair value of $45.74 and $42.35 based on 5- and 10-year averages, respectively. The consensus from analysts is that earnings will rise at 3.58% per year over the next five years. If we take a more conservative number at 3%, running the three-stage DCF analysis with an 8% discount rate (expected rate of return), we get a fair price of $36.73. The following charts from F.A.S.T. Graphs provide a perspective on the valuation of SO. (click to enlarge) (Source: F.A.S.T. Graphs ) The chart above shows that SO is slightly undervalued. The Estimates section of F.A.S.T. Graphs predicts that at a P/E valuation of 15, the 1-year return would be 2.75%. (click to enlarge) (Source: F.A.S.T. Graphs ) Conclusion Electric utilities in general have seen slower sales industry-wide amid a combination of energy conservation, energy efficiency and shift towards independent power generation/natural gas usage. Coupled with the new regulations from the US government to reduce carbon emissions, electric utilities have started focusing a shift away from dirty fuels such as coal. Southern Company still relies heavily on coal, but has started focusing on cleaner energy alternatives to meet the target. In a move to diversify and fortify its assets, the company is moving to acquire AGL Resources Inc. in a deal financed by new share and debt issuance. While this is good for the overall company’s business, in the short term (over the course of next few quarters/years) some balance sheet damage can be expected as the company takes on more debt and investors see share dilution. An added risk for investors is the potential rise of interest rates by the US Fed. Bond substitutes such as utility stocks suffer the most in rising rate environments. Based on the metrics discussed above, if we give equal weight to all metrics, we get a fair value of $45.31. Full Disclosure: None. My full list of holdings is available here .

Does FlexShares’ New Corporate Bond ETF Stand Apart?

Corporate bond market has been hit by global growth concerns lowering the investor outlook on the credit worthiness of the corporations as well as looming interest rate hike. Further, there are concerns about corporate bond market liquidity (read: 3 Bond ETFs to Consider in a Market Slump ). In an attempt to take care of this situation and attract the investment grade corporate bond ETF investors, FlexShares – a unit of Northern Trust Corporation (NASDAQ: NTRS ) – has launched the FlexShares Credit-Scored US Long Corporate Bond Index Fund (NASDAQ: LKOR ) , which focuses on longer maturity corporate bonds. LKOR in Details LKOR follows a recently developed Northern Trust Credit-Scored US Long Corporate Bond Index. As per FlexShares, the index covers a liquid issuer universe, employs a proprietary model for credit scoring and optimizes the index’s constituents to maximize the credit score while maintaining duration, spread and other investment grade-like characteristics. More than 66% of LKOR’s holdings have maturities ranging from 20 to 30 years while more than 27% have maturities ranging from 15 to 20 years. This results in a weighted average effective duration of 13.25 years, as per the issuer. The ETF comprises 136 holdings with Apple Inc. ( OTC:APPL ) occupying the top position with 1.43% share, followed by Time Warner Inc. (NYSE: TWX ) with 1.34% share and JPMorgan Chase & Co. (NYSE: JPM ) with 1.29% share. The top 10 holdings constitute around 12.5% of the fund. As far as sector allocation is concerned, Industrials (23.7%), Consumer (20.8%) and Energy (18.9%) make up the top three positions. Considering country-wise allocation, the fund is heavily biased towards the U.S. with 87.6% share while Canada, U.K., Netherlands, Australia and Spain hold minimal shares. The fund is cheap as it charges only 22 bps in fees from investors per year (see all Investment Grade Corporate Bond ETFs here). How Does it Fit in a Portfolio? LKOR seems to have addressed the investors’ concern about the companies’ ability to repay their debt as economic slowdown in China and low commodity prices may lead corporations to face financial crisis. This is because the issuer has targeted corporate bonds with higher credit quality, lower risk of default and potential for higher yield and price appreciation. On the Standard & Poor’s ratings scale, the fund’s quality breakdown includes investment-grade ratings AAA (2%), AA (14.8%), A (36.6%) and BBB (46.6%). Moreover, the fund seeks to improve liquidity and transparency by excluding illiquid and smaller issuers. The question of liquidity is of high importance as banks, serving as brokers, have reduced their inventories of corporate bonds following post-financial crisis regulations, making bond trading difficult. It is for these reasons the issuer has stated that the ETF provides “a contemporary approach to optimizing credit risk, with improved transparency and liquidity relative to legacy corporate bond benchmarks”. ETF Competition LKOR definitely stands apart from other long term corporate bond ETFs as it addresses the present ailments in the corporate bond market. Still, there are a number of such ETFs that worth to mention due to their popularity. A couple of long term corporate bond ETFs includes the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD ) and the Vanguard Long-Term Corporate Bond Index ETF (NASDAQ: VCLT ) . LQD tracks the iBoxx $ Liquid Investment Grade Index focusing on 600 highly liquid investment grade corporate bonds in the U.S. It has an asset base of $22.1 billion and focuses on all-term bond duration. On the other hand, VCLT follows the Barclays U.S. 10+ Year Corporate Index focusing on corporate bonds issued by industrial, utility, and financial companies, with over 10 years in maturities. It manages an asset base of $991 million. Both LQD and VCLT look attractive on the cost front with expense ratios of 0.15% and 0.12%, respectively. However, in terms of yield, VCLT (4.14%) is a better option than LQD (3.13%). Link to the original post on Zacks.com

Spark Up 12.5% Yields With Edenor Yankee Bonds, Maturing October 2022

Summary Edenor is the largest electricity distribution company in Argentina. It registered a more than 200% increase in its profit from continuing operations for the first six months (ended June 30) of 2015, compared to the same time period in 2014. Currently, Edenor stock is up 47% from the beginning of 2015. This week we focus on a monopolistic company providing an essential service within its captive market. Empresa Distribuidora y Comercializadora Norte S.A (NYSE: EDN ) is the largest electricity distribution company in Argentina, providing service to a large majority of Argentina’s largest city, Buenos Aires. After many years of government imposed tariff rates, recent legislation has not only provided additional revenues, but has laid the groundwork for a long-overdue increase in the rates Edenor can charge to its customers. These additional revenues have had an extremely positive effect on Edenor’s financials, with the company registering more than a 200% increase in its profit from continuing operations for the first six months (ended June 30) of 2015, compared to the same time period in 2014. With Argentina’s national elections next month, the international business community is anticipating the positive economic reforms that may come from a new ruling government, including long-overdue tariff increases for electricity distributors and generators. These slightly longer seven-year bonds, couponed at 9.75% and currently indicated a yield of about 12.5% when discounted to about 87.5, offer very high cash flow and represent an excellent opportunity for savvy investors to participate in the renaissance of the Argentine economy. Therefore, we are targeting them as a strong addition to our FX1 and FX2 income portfolios. Argentine Yankee Bonds Three years ago, we began finding great opportunities in many of Argentina’s nicely discounted dollar-denominated short-term bonds. While the high yields that were indicated turned away many of the typically more conservative fixed investors, the previously recommended Argentina bonds, as a group, have continued to remain on track toward producing remarkably high yields that are over 8% (and some upwards of 14%). As a group, the Yankee bonds from Argentina have significantly outperformed all other segments of our global high-yield portfolios. About the Issuer Empresa Distribuidora y Comercializadora Norte S.A. (Edenor) is the largest electricity distribution company in Argentina in terms of number of customers and electricity sold. Through a concession, Edenor distributes electricity exclusively to the northwestern zone of the greater Buenos Aires metropolitan area and the northern part of the city of Buenos Aires, which has a population of approximately 7 million people. Edenor’s ultimate parent company is Pampa Energia, the largest, fully integrated, electricity company in Argentina. Pampa is involved in all aspects of electricity, including generation, transmission and distribution. Edenor has a geographic monopoly in the area where it provides electricity service. In Argentina, each distributor supplies electricity to consumers and operates the related distribution network in a specified geographic area pursuant to a concession granted by the Argentine government. Only one concession is granted in each area. Increasing Tariff Rates After over a decade of frozen tariff rates, the Argentine government is finally conceding to the need for increased rates in the electricity sector. In March of this year, Argentina’s Secretary of Energy passed legislation that will pave the way for Edenor and other distributors in the country to raise tariff rates for the first time since 2007. Until those rates are officially increased later this year, the government will transfer funds to the company to cover the difference between current rates and actual distribution costs. The big picture of this legislation for Edenor in 2015 is an estimated US $455 million in additional revenues. In fact, Edenor had already received an additional $262.8 million as of June 30, 2015. This legislation (known as Resolution 32/15) has been well received by the financial markets, with Edenor stock rising to its highest point in March 2015 since the company’s stock began trading in 2007. Currently, Edenor stock is up 47% from the beginning of 2015. Edenor also has been anticipating the long-awaited rate increases and is in the process of drafting a new 10-year investment plan to update and upgrade its distribution network. Political Changes Argentina’s much anticipated elections will take place on October 25, 2015. Due to term limits, current Argentine President Kirchner will not seek reelection. Many Argentine citizens, as well as many in the financial world, are anticipating that the next ruling government will enact changes long overdue under President Kirchner’s watch. These changes include lifting trade barriers, amending price controls and reducing subsidies. The heavily subsidized electricity industry, which currently experiences outages during peak demand times, will likely be one of the first areas the new government will address. With the recently enacted legislation, industry experts predict the first order of business will be to raise tariff rates to a level more reflective of the actual costs for energy distribution. These higher rates will definitely favor Edenor, increasing the company’s cash flow, bolstering its operating margins and improving its credit rating. Financials Edenor’s financials have shown marked improvement with the addition of the revenue tied to the March 2015 legislation. For the six months ended June 30, 2015, the company had a profit of AR724.7 million from continuing operations compared to a AR722.8 million loss for the first six months of 2014. Q2 2015 also showed an impressive year-over-year increase in adjusted EBITDA. Edenor registered an adjusted EBITDA of AR310.0 million compared to a loss of AR$479.3 million for Q2 2014. As one might expect, Edenor has significant asset value in its property, plant and equipment. As of June 30, 2015, the company recorded $807.5 million (in US dollars) in asset value for its property, plant and equipment. This value well exceeds the company’s dollar-denominated debt of $191.2 million. Risks The default risk is Edenor’s ability to perform. After over a decade of artificially low tariff rates, it’s encouraging that the Argentine government is finally acknowledging the need to adjust rates to more accurately reflect the actual cost of electricity distribution. Edenor’s cash flow and operating margins have improved significantly since legislation was passed earlier this year to direct additional revenues to the company to more closely match actual operating expenses. Given Argentina’s history of government regulation in the private sector, there is certainly some geopolitical risks involved for bondholders of Edenor. With national elections only a month away, the international consensus is that whatever new government comes to power will need to contend with remedying the many areas of Argentina’s economy that have suffered under the current ruling party, including the aging electricity infrastructure. This will most certainly involve reducing subsidies (to shore up Argentina’s reserves) as well as raising electricity rates, which will translate to increased income for Edenor. Also, as electricity is an absolute essential need for any modern society, the government will do whatever is required to ensure Edenor’s viability. Edenor’s current dollar denominated debt totals $191.2 million (in US dollars). A decline in the Argentine peso would increase Edenor’s interest payments on this debt as their revenues are recognized in Argentine pesos. Even if a devaluation of the Argentine peso occurs after the upcoming election (as many are predicting), the expected increase in tariff rates for Edenor will help to balance peso volatility. These bonds have similar risks and yields to other Yankee bond issues reviewed on BondYields.com , such as the 8.875 Transener Yankee bonds , the 9.5% Autopistas Del Sol Yankee bonds and the 7.75% Hidroelectrica Piedra del Aguila Yankee bonds. Summary and Conclusion Edenor provides an essential service to the citizens of Argentina’s largest city, Buenos Aries. Although the company has had challenges in trying to match revenue with costs due to the long-standing tariff freeze, the tide has turned, as evidenced by the recent rally in Edenor stock, with the Argentine government moving toward allowing rate increases by the end of this year. Any such increase will have a positive effect for Edenor – increasing operating margins and allowing the company to update its aging systems. For bondholders, Argentina represents an excellent diversification opportunity into a country poised to make significant economic progress with the advent of a new ruling government. These 9.75% couponed bonds have a slightly longer duration than many of the bonds previously reviewed, but we like the monopolistic position of Edenor along with the essential service it provides to the city and country where it operates. Consequently, we believe the high 12.5% yields indicated with these bonds will make an excellent addition to our Fixed-Income1.com and Fixed-Income2.com global high yield fixed income portfolios. Issuer: Empresa Distribuidora y Comercializadora Norte S.A. (EDENOR) Coupon: 9.75% Maturity: 10/25/2022 Rating: B2/B CUSIP: P3710FAJ3 Pays: Semi-annually Price: 87.5 Yield to Maturity: ~12.5% Disclosure: Some Durig Capital clients may currently own Edenor’s 2022 bonds. Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.