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Best S&P 500 Utility Stocks According To Zweig Principles: Consider Ameren Corporation

Summary Ranking the top 20 S&P 500 utility stocks according to “All-Stars: Zweig” ranking system. Explanation and back-testing of the “All-Stars: Zweig” ranking system. Description and a buy recommendation for the first-ranked stock of the system: Ameren Corporation. S&P 500 utility stocks have underperformed on average the S&P 500 index over the last year. The average return of the 29 S&P 500 utility stocks that are included in the S&P 500 index (included dividends) in the last 52 weeks has been only 0.18% while the S&P 500 index has returned 2.96%. The table below shows all S&P 500 utility companies, ranked according to their 52-week return. (click to enlarge) On one previous article from September 15, 2014, I described the “All-Stars: Zweig” ranking system. However, in this article, I updated the backtesting of the system and ran it on another group of stocks. The “All-Stars: Zweig” ranking system is quite complex, and it is taking into account many factors like EPS Growth, Sales Growth, Market Performance and Insiders activity, as shown in the Portfolio123’s chart below. To find out how such a ranking formula would have performed during the last 17 years, I ran a back-test, which is available through the Portfolio123 ‘s screener. For the back-test, I took all the 6,555 stocks in the Portfolio123’s database. The back-test results are shown in the chart below. For the back-test, I divided the 6,555 companies into 20 groups according to their ranking. The chart clearly shows that the average annual return has a very significant positive correlation to the “All-Stars: Zweig” rank. The highest-ranked group with the ranking score of 95-100, which is shown in the light blue column in the chart, has given the best return – an average annual return of about 17%, while the average annual return of the S&P 500 index during the same period was about 3.2% (the red column at the left part of the chart). Also, the second, the third group, and the fourth group (scored: 90-95, 85-90, and 80-85) have yielded superior returns. This brings me to the conclusion that the ranking system is very useful. After running the “All-Stars: Zweig” ranking system on all S&P 500 utility stocks on November 24, I discovered the 20 best stocks, which are shown in the table below. In this article, I will focus on the first stock of the list: Ameren Corporation (NYSE: AEE ). (click to enlarge) Company Description St. Louis-based Ameren Corporation powers 2.4 million electric customers and more than 900,000 natural gas customers in a 64,000-square-mile area through its Ameren Missouri and Ameren Illinois rate-regulated utility subsidiaries. Ameren Illinois provides electric delivery and transmission service as well as natural gas delivery service while Ameren Missouri provides vertically integrated electric service, with generating capacity of over 10,200 megawatts, and natural gas delivery service. Ameren Transmission Company of Illinois develops regional electric transmission projects. In 2014, the company generated 61% of its electricity from coal, 16% from its Callaway nuclear plant, 2% from hydro sources, 1% from gas, and 20% from outside purchases. (click to enlarge) Source: Edison Electric Institute Financial Conference On November 06, Ameren Corporation reported strong third quarter 2015 financial results, which beat EPS expectations by a big margin of $0.11 (8.5%) and raised the low end of its core EPS guidance range to $2.55 to $2.65 from $2.45 to $2.65 previously. The company showed significant earnings per share surprise in three of its last four quarters, as shown in the table below. Data: Yahoo Finance Ameren announced net income attributable to common stockholders of $343 million, or $1.41 per diluted share, for the third quarter of 2015, compared with $293 million, or $1.20 per diluted share, for the third quarter of 2014. The year-over-year increase in third quarter 2015 earnings reflected higher retail electric sales volumes driven by warmer summer temperatures that were near normal. The comparison also was favorably affected by earnings on increased investments in electric transmission and delivery infrastructure made under formula ratemaking. In addition, earnings benefited from a seasonal rate redesign and the timing of revenues under formula ratemaking for Ameren Illinois’ electric delivery service as well as a lower effective income tax rate. In the report, Warner L. Baxter, chairman, president and chief executive officer of Ameren, said: We are on track to deliver strong earnings growth in 2015. This growth is driven by the execution of our strategy, which includes allocating capital to jurisdictions with modern, constructive regulatory frameworks and managing our costs in a disciplined manner for the benefit of all our stakeholders. In my view, Ameren is well positioned to achieve its target for strong long-term earnings growth. According to the company, it expects 7% to 10% compound annual EPS growth from 2013 through 2018. Ameren’s $8.9 billion, five-year regulated capital spending plan should help to drive long-term EPS growth. The formulaic Illinois rate structure is constructive, and with increased capital expenditures in the Illinois utility, rates will increase further. The company is waiting for rulings from the Illinois Commerce Commission about an electric delivery formula rate increase along with a natural gas delivery rate case that would raise rates. A decision in these cases is expected in December. The company is experiencing a more favorable regulatory climate at the state level than in the recent past, and, under a Federal Energy Regulatory Commission formula rate plan, is benefiting from returns on its transmission buildout program, which are usually higher than the returns earned on electricity generating and distribution assets. All in all, Ameren is a reliable, fully regulated utility that should provide investors with growing dividend income and long-term share price appreciation. Valuation Year to date, AEE’s stock is down 6.0% while the S&P 500 Index has increased 1.3%, and the NASDAQ Composite Index has gained 7.7%. Moreover, since the beginning of 2012, AEE has gained only 30.8%. In this period, the S&P 500 Index has increased 65.9%, and the Nasdaq Composite Index has risen 95.9%. AEE Daily Chart (click to enlarge) AEE Weekly Chart (click to enlarge) Charts: TradeStation Group, Inc. Ameren’s valuation is fairly good. The trailing P/E is at 16.25, and the forward P/E is at 15.93. The price to book value is at 1.53, and the Enterprise Value/EBITDA ratio is low at 8.32. On October 09, the company declared a quarterly cash dividend on its common stock of 42.5 cents per share, a 3.7% increase from the prior quarterly cash dividend of 41 cents per share, resulting in an annualized equivalent dividend rate of $1.70 per share. The previous annualized equivalent dividend rate was $1.64 per share. The forward annual dividend yield is pretty high at 3.92%, and the payout ratio at 61.2%. The annual rate of dividend growth over the past three years was at 1.2%, and over the past five years was at 0.9%. Ameren expects the dividend payout ratio to be between 55% and 70% of annual earnings. AEE Dividend data by YCharts Summary Ameren delivered strong third quarter 2015 financial results, which beat EPS expectations by a big margin and raised the low end of its core EPS guidance range to $2.55 to $2.65 from $2.45 to $2.65 previously. The company showed significant earnings per share surprise in three of its last four quarters. In my view, Ameren is well positioned to achieve its target for strong long-term earnings growth. According to the company, it expects 7% to 10% compound annual EPS growth from 2013 through 2018. Ameren’s $8.9 billion, five-year regulated capital spending plan should help to drive long-term EPS growth. The company recently raised its dividend by 3.7% to a new annual rate of $1.70 per share. The forward annual dividend yield is pretty high at 3.92%. All in all, Ameren is a reliable, fully regulated utility that should provide investors with growing dividend income and long-term share price appreciation, and its stock is an investment opportunity right now.

Laclede Group: Aggressive New Management Is Performing

Summary Laclede doubled its enterprise value in two years via acquisitions. Debt and leverage has ballooned, but so has cash flow from operations. I’m not fully sold on recommending the shares for income investors until I see a solid bump in the dividend. The Laclede Group (NYSE: LG ) is a regulated natural gas utility that has begun making waves in the utility industry over the last several years. Through the acquisitions of Missouri Gas Energy from Southern Union in 2013 and Alagasco from Energen (NYSE: EGN ) in 2014, Laclede Group has shifted from a relatively small utility serving just a portion of the Missouri natural gas market to serving millions of customers, holding dominant market positions in both Missouri and Alabama. Shares in the company have rebounded nicely off early September lows and now trade at all-time highs. Are investors putting too much faith in the future of the company, especially given its less-than-stellar service area? Business Environment Utilities can add incremental revenue in two ways. They can either have customers consume more of the commodity, raise rates on current customers, or add new customers. The first method is unlikely, given that U.S. consumers are consuming less electricity per capita now than in prior years. The advent of energy conservation, more efficient appliances, and less household formation has ensured that the trend is going to remain in a slow slide downward outside of freak weather years increasing demand. With that off the table, utilities like Laclede Group could raise prices on consumers. Not going to fly, because as we know these are regulated operations and public utility commissions set the allowed returns. So the third option (influx of new customers) is really the only source and is something completely out of the utility’s control. This is why there is such a focus on market analytics when valuing utilities. Analysts look at all sorts of factors in the company’s service area: unemployment, average wages, past years’ population growth, etc. Sadly for Laclede, there won’t be much to like here. Missouri and Alabama rank average or below average on nearly every metric you could look at. Unemployment, salary averages, labor participation, poverty, etc. are all below average compared to other states. This scares away many investors, and rightly so. Until these states turn the corner and can draw in new inflows of people, Laclede should likely trade at a discount compared to better positioned peers. Operating Results There has been a lot of change for Laclede Group over the past three years. In fiscal 2011, the company switched CEOs to current leader Suzanne Sitherwood, who made quick work of making changes within the company. Within a few short years under her leadership, the company had sold off its propane assets, made $2.2B worth of acquisitions, and driven up profit/operating margins. Acquisition and expansion don’t come for free, however. Long term debt has spiked from $340M in 2011 to over $1.7B today. Net debt/EBITDA has expanded from a low of 2.1x in fiscal 2011 to what should be around 4x in fiscal 2015. While this is a manageable level of debt for a utility, long-time holders of Laclede should be aware that the risk profile has changed dramatically under the new management style. Excluding the impact of the acquisitions on the cash flow statement ($2.2B paid for with approximately two thirds long-term debt, one third stock offering) things actually look pretty good. Cash from operations is set to fly high in 2015, with the business generating more cash in 2015 than in the prior three years combined. Capital expenditures, like is the case for most natural gas utilities, are comparatively low and under control compared to other utilities that operate in power generation. Results here are ideal and indicative of how I want to see a utility being managed in respect to cash in/cash out. Conclusion Ballsy moves aren’t something the utility industry is known for. Laclede has bucked this trend by engaging in acquisitions that doubled its size in just a few short years. There will be growing pains associated with the acquisitions that may impact short-term results, but I think thus far it looks like company management has made the right play and acquired some solid assets that will easily be folded under the Laclede umbrella. I think investors see the potential here, which is why shares have performed so strongly. For income investors considering entering a position, however, I think this is a “show me” story. Historical dividend growth has been lackluster and I think investors considering going long should wait to see what the next dividend increase pans out to be in fiscal 2016, which should be announced over the next few months. A bump in the 5%+ range would show that management is hitting their targets while also being shareholder friendly.

CenterPoint Energy: Be Sure To Understand What You Own

Summary CenterPoint currently yields nearly 5.35% and has $1.2B in cash reserves. Transmission and distribution income – nearly 50% of operating income – is geographically concentrated. It is largely considered to be a utility – however, a quarter of the income is derived from the MLP equity interest, which has been historically volatile. CenterPoint Energy (NYSE: CNP ) is a diversified pseudo-utility with a wide range of operations. The company operates a regulated natural gas utility business, a transmission and distribution arm, and retains ownership of substantial equity interest in Enable Midstream Partners (NYSE: ENBL ). CNP has been a favorite of investors chasing yield, but the shares have had trouble keeping up with the utility index over the past two years. Unfortunately for shareholders, the shares are down 20%, compared to a 20% gain for the broader utilities index. Contrary to what you might think, the dividend has actually been growing measurably the past two years, and the company now yields over 5.49%, well above historical averages. Is there an opportunity here for shareholders for both solid yield and capital appreciation? Business Operations CenterPoint’s strongest business unit in regards to operating income is its electric transmission and distribution business. This segment provides the infrastructure to connect power plants to substations which connect to the retail customer. This is a low-business risk, high-value business. Because the infrastructure is entirely pole/wire assets, there is significantly less regulatory and environmental risk compared to actual power generation. While this is a monopolistic business with very little risk, CenterPoint’s operations do have geographic risk in that the company only owns assets located in and around the House/Galveston metropolitan area. While this area has retained its strong growth even with the fallout of plummeting energy prices, there is no guarantee that this trend will continue. A reversal in the area’s fortune would result in a slowdown in demand for electricity, driving earnings down in this segment. The most stable and consistent business unit is CenterPoint’s intrastate natural gas distribution business. Compared to the transmission and distribution business that is concentrated in one area, this segment provides natural gas to more than three million customers in six states. Like other gas utilities, the company passes along the cost of the gas to customers, so there is little effect of gas price fluctuations on CenterPoint’s profitability aside from revenue numbers. Further cementing operating results, the company has weather normalization and decoupling mechanisms in place to limit the effects of seasonality and variations in customer demand in five of six states. This portion of CenterPoint is extremely well run, and earnings consistently bump up against the maximum allowed rate of return that the public utility commissions have set for the company (authorized return on equity in the 10% range). As mentioned, CenterPoint owns 55.4% of the limited partner units of Enable Midstream Partners, receiving 40% of the distribution rights. Operational control is split 50/50 between CenterPoint and OGE Energy (NYSE: OGE ). The reason for CenterPoint’s underperformance may largely lie with poor results from Enable. Enable’s first half of the year has been poor when compared to the 2014 results ($93M in operating income for Enable in 1H 2015, compared to $138M in 1H 2014). The downside action in Enable may have been overdone. Compared to many midstream companies like Kinder Morgan (NYSE: KMI ), the company is much less levered (2.6x net debt/EBITDA), making it better positioned to handle any long downturn in U.S. energy midstream operations. I think the weak recent share price performance is primarily related to the company’s short public history and heavy insider ownership. With very little track record and such a small percentage of the float open for trading, the shares have been volatile, scaring many retail and institutional investors away. Operating Results (click to enlarge) Revenue can vary widely year to year, especially within the natural gas distribution segment. As an example, revenue grew 40% from 2012 to 2014 ($959M), but operating income only grew 26% ($60M). This can cause operating margin decreases through no fault of the company as these operating margins decrease as the fixed cost of the natural gas being provided rises. Meanwhile, further putting pressure on operating margins has been a steady increase in operations and maintenance costs within the electric transmission and distribution segment. Between 2012 and 2014, revenue grew 12%. Regrettably, operations and maintenance costs grew 32%. While its maintenance capital expenditures will be recovered as part of capital plans eventually, these recoveries may not be as timely as investors might expect. (click to enlarge) 2014 was a concerning time for the company from a cash flow perspective. Cash from operations had fallen nearly $500M from 2012 levels, and capital expenditures were up tremendously. CenterPoint had to plug the hole with the $600M in proceeds from long-term debt it had raised late in the year prior. With $6.4B in net debt, the company is only moderately leveraged at 3.2x net debt/EBITDA. However, with CenterPoint keeping $1.2B in cash and cash equivalents on the balance sheet, it is prepared to weather any mild operational issues quite well. Conclusion When investing in CenterPoint, investors need to be aware they aren’t buying a company with 100% regulated utility operations. The higher dividend yield here is likely justified, given the volatility present in the Enable ownership. On the plus side, the natural gas operations are very well run, and the electric transmission business, while experiencing headwinds currently, is also solid. In my opinion, the shares likely trade around their fair value. Investors looking for yield can likely comfortably add some exposure to the company in the $17-18/share range.