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Why I’m Still Not Interested In NextEra

NextEra represents one of the most socially responsible industrial investments, but we believe valuations are not good enough to buy. The company continues to see a battle over what we believe is their largest catalyst – Hawaii. The company’s business remains strong in regulated markets. NextEra (NYSE: NEE ) has recovered about 5% since the last time we looked at the company, and today, we want to take a fresh look at the utility play after their latest round of earnings. We first looked at the company in late February and followed that with an update in June as well as September . As we have previously noted, we like a lot of aspects of NextEra but have not seen the value in 2015, feeling the company is fairly valued for the year. As we near year-end, how did we do? The stock is down 3% on the year as we felt it was worth in best-case scenario $96. The issues that we believe have kept valuations in check as well as our thesis is margin compression and consistency as well as the potential for the Hawaiian Electric (NYSE: HE ) deal. Today, we will wrap up our 2015 catalysts, look towards the future with 2016, and talk about potential targets for 2016 pricing. 2015 Catalysts Concluded, 2016 Focus Economic Moat Strength For us, in 2016, the main reason you invest into NextEra remains the same. The key strength for NEE remains its economic moat that exists from non-competitive agreements that the company has with many municipalities. These type of agreements mean that the company has negotiated a “fair price” deal with a certain geographic area that does not allow competition to enter the market. The idea is that it keeps prices lower for citizens and allows the company to also benefit from non-competition. NEE is attractive because 80% of its business is in the regulated area, which means higher margins, consistent revenues, and low risk for investors. This image from Market Realist tells the tale: (click to enlarge) (click to enlarge) In the latest earnings call, the company talked about its largest regulatory marketplace – Florida Power and Light: We continue to execute on our overall customer value proposition by delivering clean energy, low bills, and high reliability for Florida customers. Each of our capital deployment initiatives to provide low-cost, clean energy continues to progress in accordance with our development plans. Our generation modernization project at Port Everglades is on schedule to come online in mid-2016 and remains on track to meet its budget. Development of our three new large-scale solar projects remains on schedule, with each of these roughly 74 megawatt projects expected to be completed in 2016. These projects, once complete, will roughly triple the solar capacity on our system and add to the overall fuel diversity of our fleet, which is important for FPL and its customers. Will anything change on this front in 2016? The major regulatory change to watch in 2016 has to do with Hawaii not Florida. The company is seeking state approval after they acquired HE, and that has been the main focus of our articles in the past…it will remain our focus for 2016 as well. The company stands to benefit a lot from adding HE to this high margin regulated environment, and a lot of the value in the company is embedded in that opportunity. Hawaii – Another Regulated Market to Add Shareholder Value As we have noted previously: In 2014, NextEra bought Hawaiian Electric ( HE ) for north of $4B. The move was a chance to come into a new market that was in need of cost savings and be able to combine a regulated market with the company’s practice of making efficient utility deliveries. Further, NEE wanted to be able to bring its ability and knowledge of scaling renewable energy in an area that is burdened by extreme energy costs. Between the company’s initiatives in solar energy and knowledge of other sources, NEE stands to be able to generate a very strong value proposition for Hawaii while also continuing to promote its economic moat. So, how have things been moving since the last time we looked at the company… The last two times we have investigated NEE the key aspect for the company has been getting regulatory approval from Hawaii. When we first looked at the acquisition, NextEra was quite confident they could get the deal done in a timely fashion. Since then, things have gone up and down. For example, in April, HE’s CEO came out saying he was confident that the deal would be completed within a year, and the Hawaiian House of Representatives put a resolution in place to complete the deal by June 2016. Given the market is regulated, it is a major decision for Hawaii, consumers, etc. Yet, in the last report, we noted that the Governor of Hawaii had come out at least much less confident in the deal if not against the acquisition. As CEO James Robo noted: Steve this is Jim, obviously the state filed a testimony ten days ago saying that they opposed the deal in its current form and the Governor held a press release where he, press conference where he said he opposed the deal in its current form. I think the key, the keywords there in its current form, they also, the state also listed several conditions that would be, I think just positive for them to think about changing their view. And we are in the process of responding to that testimony and we think we have a very strong case to put forward to the Commission around the benefits to customers, the benefits to customers were actually pretty compelling and I think we’re going be able to make that case as we go forward. So, this was not necessarily a surprise to me that the state filed a kind of testimony that they did and we are going to continued to move forward on laying out our arguments and we look forward to the hearings we’re going to have in December to make our case. This news was not exactly the type of “positive” news that the company had hoped for. Since that comment in July, the Governor has said the process was still very early, and that he is looking forward to the company’s responses to testimony it presented. The process had grinded to halt. In the latest earnings call, the company noted: Steven Isaac Fleishman – Wolfe Research LLC And then, lastly, just could you maybe give us any color or latest thoughts on the Hawaiian Electric deal? James L. Robo – Chairman, President & Chief Executive Officer Sure. So we continue to work hard to get the final hurdle, which is state regulatory approval in Hawaii. We have recently gotten a couple intervenors to either fall away or announce their support, and I was very pleased that the IBEW announced their support for the transaction last week. And we continue to work it. I think my expectation, based on timing right now, is that we’re not going to get any kind of decision from the PSC until next year, and so we’re going to continue to work it and continue to talk to the parties to try to get it across the finish line. That was the company’s only mention in the call of the deal. Outside of the earnings, the news has been moving positively. As Robo noted, the largest union of electrical workers, representing 1500 workers, came out in support of the acquisition. That type of support is the kind that the company needs as they are seeking approval. The issue has come down to that the Governor wants 100% renewable energy in Hawaii by 2045. NextEra has not made those types of promises. Electricity is extremely expensive in Hawaii, so the move to all renewable would dramatically decrease costs and Hawaii’s dependence on shipping in electricity. NextEra came out recently saying that it would take $30B to get to that 100% renewable energy: Eric Gleason, president of NextEra Energy Hawaii LLC, said at a Waikiki business luncheon this week that getting the state off its dependence on oil would cost $30 billion over the next three decades. “There is no utility in the country that has as much on its shoulders as Hawaiian Electric does right now,” Gleason said. “Hawaii needs a financially very strong utility to either make or backstop something like $30 billion of investments over the next few decades. … There is a big need for capital to make all of this happen.” That number has scared the PUC, which approves the deal. They believe that cost will be passed onto customers, which would make high bills rise even more. The idea of HE getting the capital and infrastructure from NEE was that bills would get lower, but NEE argues that if it is predicated on getting to 100% renewable energy…it can brings bills down. Thus, we have the stalemate. With more support being thrown to NEE, the company has more grounds to pressure the government. We will continue to see this issue for the coming months, and the company’s getting the deal done in the timeframe they originally expected does not look likely. Does this materially change the outlook for NEE? It does not change any revenue/profits, but it changes potential revenue and profits. The deal added about 10% to the value of the stock, so if it falls through or is derailed…we could see that type of reduction in prices as well as our model. 2016 Pricing The company’s 2016 pricing will be delayed for us as we don’t see any material change in our current valuations with one more quarter to go in FY 2015 and the Hawaii deal in limbo. For now, we continue to like the $96 price tag we had originally floated at the beginning of the year. For 2016, we are set to see that price tag increase by the rate of earnings increasing, which is estimated at 5%. If Hawaii does go through, this could change this model, so we want to wait to see how this plays out and FY 2015 closes out. Conclusion NextEra has interesting catalysts to 2016, but a lot of the potential for another major run will be predicated on getting Hawaii right. The company’s valuation has come down with the flat move in the share price this year, which does set it up for probably a 5-10% move in 2016. Without success in Hawaii, though, we could see another flat to weak year in FY 2016. Recent issues in Hawaii Electric ( HE ) make me nervous, but the rest of the company’s business is extremely intriguing and strong, which neutralizes my fears there. With PEG still over 2.0, though, we aren’t interested in dipping a toe at this time still.

The Proper Intellectual Framework For Assembling An Investment Portfolio

Summary Making asset allocation decisions using a backward looking framework based on the global financial portfolio ensures mental rigor. Investors asset allocation decisions should take into account current conditions. Investors will need to adjust expectations and allocations as equity and bond returns will likely be lower than in the past. We’ve written a several articles in the past about what investments and assets classes shouldn’t be in your portfolio such as commodities , currency funds , and bank loan funds . We also wrote a few articles about asset classes that should be in your portfolio such as international bonds . But, we’ve never discussed how to assemble a comprehensive, well diversified portfolio. It’s important to note we are talking about an investment portfolio so we will not be considering cash which would be part of someone’s savings portfolio. In this ongoing series of articles we’ll be discussing each of the asset classes we use to assemble client portfolios. Over the next few weeks we’ll be discussing each asset class in depth and talking about what risk and reward attributes they bring to a portfolio. For this series of articles we’ve divided the asset classes into three conceptual categories: low risk, medium risk, and high risk. The links to previous articles are below. Low Risk Medium Risk High Risk How to Assemble a Comprehensive Investment Portfolio Every Investor’s Starting Point When assembling your portfolio from all the worthwhile asset classes it’s important to keep your starting point in mind. Many investors probably utilize a forward looking mental framework. They think well, I have $100,000 to invest so I’ll allocate $x to asset class A, $y to asset class B, etc. I think a better way to look at things is to take a backward looking point of view. Start with what a portfolio of all global investable financial assets would look like. From the paper in the previous link, which was published in 2011, we can see the breakdown of all financial assets in the world is as follows. We removed some assets like hedgefunds which mostly just hold duplicative positions in equities and bonds which are already included in the global portfolio. We also removed private equity funds because they are not generally available to most investors. It’s also arguable whether or not they would constitute a distinct asset class. After all, they are just funds made up of equity investments. However since those equity investments are not publicly tradable it’s likely that private equity should be considered a separate, albeit expensive to invest in, asset class. In any case, investors should use the adjusted global financial asset portfolio as a starting point and then make changes based on their preferences and goals. For example, the global portfolio is a very bond heavy. An investor with a higher risk tolerance and a desire for higher growth would likely find it much better to overweight equities and underweight government bonds as compared to the global portfolio. Investors who’ve read our articles on commodities and high yield bonds and know that neither asset provides a compelling risk versus reward ratio would know to skip allocations to those assets. An investor with extensive private real estate holdings may elect to skip or reduce their real estate exposure. Don’t Ignore Current Conditions It’s also important to not ignore current conditions when making asset allocation decisions. For example, with short term US interest rates at zero it is highly unlikely that interest rates along the entire curve will fall very far (if at all) thus US bond returns are likely to be muted during the next few years as the Fed slowly begins to raise rates. On the other hand many foreign central banks are still keeping interest rates low or negative. Thus, investors desiring both the safety of government bonds and higher returns may find overweighting currency hedged foreign bonds a good idea. Likewise, a conservative investor planning for retirement who previously may have liked a 50/50 balanced stock and bond portfolio might find that no longer adequate to meet their return goals. As we said bond returns are likely to be below historical averages and with the US stock market either fairly or perhaps slightly overvalued equity returns are likely to be average at best going forward. Therefore, our conservative investor may need to adjust his portfolio, however uncomfortable that may be, to be more aggressive in order to meet his retirement goals. The point of all of this is that deviating from the global financial portfolio is fine. In fact, I’m not sure there would be many investors for whom the global financial portfolio would be appropriate for anyway. What investors need to do, however, is make sure that there are logical reasons for choosing the asset weightings in their portfolio. Summary In summary, an investor should start with the global financial portfolio and then in a logical manner work backward in adjusting the asset allocation of the portfolio to meet their investment goals. I believe this method is most helpful as it forces investors to put more thought into why they are making the asset allocation decisions they are.

Japan In Technical Recession: Time To Buy ETFs On The Cheap?

The Japanese economy is now officially in a technical recession having shrunk 0.2% sequentially in Q3 followed by a 0.3% contraction in Q2. On an annualized basis, GDP fell 0.8% in Q3 trailed by a 0.7% (which was in fact a revised up figure) decline in the second quarter. Economists had expected a 0.2% annualized and 0.1% sequential drop for the third quarter. Per Bloomberg, lower capital expenditure by Japanese companies that resulted in soft business investment and lower inventories in the wake of global growth worries led to this miss. Though the economy is expected to step up in the ongoing quarter as companies are likely to increase output on declining ‘ stockpiles in warehouses ‘, the weak GDP numbers also led to talks about further policy easing. Views that the economy ” might have hit the bottom” in Q3 is widespread now and most people are wagering on a more beefed-up fiscal and monetary policy. Even if the Japanese corporate profile looks steady, sluggish capital spending is now a big hindrance. As per analysts, the soft global and domestic economic backdrop is restraining them from investing aggressively. Not at all. Japanese companies under Nikkei 225 delivered record earnings recently but valuations have swollen only 2.3% from the end of last year, per Bloomberg . About 55% companies under the broader Topix index beat analysts’ estimates this season. Consumer prices in Japan halted year on year in September 2015, falling from a 0.2% rise in August. Inflation in Japan has now fallen back to the level never seen since May 2013 . This boosted hopes for further monetary easing. The BOJ has now delayed the deadline for achieving an inflation target of 2% by six months. If this was not enough, after a stellar run by the ongoing QE stimulus, Japanese equity ETFs are still attractively valued. The popular Japanese ETF iShares MSCI Japan (NYSEARCA: EWJ ) trades at a P/E of 13 times at the currency level. This calls for scope for more returns out of the Japan-based ETFs. However, since yen has devalued considerably thanks to the prevailing easy money policy and the Fed is preparing for a policy tightening, a currency-hedged ETF approach is desirable in Japan investing. Though the economy Minister of Japan recently commented that “at this point the government is still not considering ‘pure’ fiscal stimulus” and that the outcome of wage negotiations for fiscal year 2016 will be a more significant growth driver than fiscal stimulus, there is a clear indication that the economy will gather steam by either one way or the other. WisdomTree Japan Hedged Equity Fund (NYSEARCA: DXJ ) DXJ looks to offer investors a way to gain exposure to the Japanese shares devoid of currency risks. This is a liquid choice in the space with 7,000,000 shares in average trading volume a day. The large-cap oriented fund has a huge asset base of $17.2 billion and charges 48 bps in fees. Toyota Motor (NYSE: TM ) (4.80%), Mitsubishi ( OTCPK:MMTOF ) (4.76%) and Japan Tobacco ( OTCPK:JAPAF ) (4.34%) take the top three spots of the fund while consumer discretionary (24.6%) and industrials (23.2%) are top two sectors. The fund was up 6.5% in the last one month (as of November 16, 2015) and has a Zacks ETF Rank #2 with a Medium risk outlook. Japan Hedged Dividend Growth Fund (NYSEARCA: JHDG ) The ETF follows the WisdomTree Japan Hedged Dividend Growth Index. The fund consists of about 248 companies. The $25.3-million fund measures the performance of dividend-paying common stocks with growth characteristics selected from the WisdomTree DEFA Index while at the same time neutralizing exposure to fluctuations between the yen and the U.S. dollar. Consumer discretionary rules the fund with about 25% exposure. Industrials (23%), IT (13.8%), consumer staples (10.6%) and telecom (10%) also get double-digit weight each. NTT DoCoMo Inc (NYSE: DCM ) (5.5%), Japan Tobacco (4.59%) and Toyota Motor (4.4%) round out the top three spots of the ETF. JHDG charges 43 bps in fees and was up 6% in the last one month. WisdomTree Japan Hedged SmallCap Equity Fund (NASDAQ: DXJS ) DXJS offers exposure to the Japanese small cap stocks while at the same time provides hedge against any fall in the Japanese yen. This is easily done by tracking the WisdomTree Japan Hedged SmallCap Equity Index. The fund has accumulated $196.5 million in its asset base and charges 58 bps in fees per year from investors. Volume is moderate as it exchanges 80,000 shares in hand per day on average. The product holds 618 stocks in its basket with none accounting for more than 0.95% of assets. Industrials and consumer discretionary take the top two spots with around 24% share each, while materials, financial and information technology round off the top five. The ETF gained 4.9% in the last one month and has a Zacks ETF Rank #2. Original Post