CenterPoint Energy: Utility Assets In A Petri Dish
CenterPoint combines electric utility, natural gas utility, and midstream assets. Weakness in natural gas prices and a potential slowdown in Houston’s economy is creating anxiety among investors, and anxiety is the Petri dish of investor opportunity. The current yield of 5.3% makes patience waiting for a turn in CenterPoint’s markets an acceptable investment strategy. CenterPoint Energy (NYSE: CNP ) is an interesting electric and gas utility servicing Houston and Minneapolis as its two biggest markets. Within the overall consolidation trend in the utility sector, combined with the current appetite electric utilities have for gas utility and infrastructure exposure, CNP could become an interesting acquisition. According to its most recent investor presentation , CenterPoint is three regulated companies in one. In 2013, CNP spun-off and currently owns 55% of MLP Enable Midstream (NYSE: ENBL ). CNP is majority owner of the general partner and income from the Midstream Investments segment comprised 25% of 2014 operating income. Electric transmission and distribution segment services the electric needs of the greater Houston area, and accounted for 48% of 2014 operating income. Houston Electric owns no generating facilities and is regulated by the Texas Railroad Commission, the state regulatory body. Natural gas distribution in Texas and surrounding states combined with greater Minneapolis territory accounted for 23% of 2014 operating income. Other Energy Services chipped in 2%. CNP reports quarterly results as Midstream Investments and Utilities. CenterPoint’s service territory is outlined below: (click to enlarge) CenterPoint’s Midstream Investments performance has increased the share price and income volatility. In step with the current downdraft in the energy sector, income attributed to Midstream Investments has fallen significantly. In 2014, Midstream Investments generated $308 of reported equity income. For the second quarter 2015, Midstream Investments generated $43 million of reported equity income, substantially below last year’s $74 million. However, with the most recent quarterly distribution of $73 million, this segment’s cash flow has remained about the same. As with many MLPs, Midstream Investments fortune is tied to natural gas markets, and the midstream segment should improve with higher demand and prices. According to the latest presentation and factoring in its ownership interest, Midstream Investments equity income will move $13 million, or $0.04 a share for every 10% move in natural gas, ethane, and NGL prices. Management has offered guidance of Midstream Investments distribution income growth in the 3% – 7% range over the next two years, based on $3.15-$3.65 Henry Hub and $60-$70 WTI pricing by 2017. The Utility segment offers a balance to the volatility of Midstream Investments, but is not without its own concerns. Houston Electric generated 48% of 2014 income, or $595 million. Some fear a slowdown in the Houston metro area caused by a deepening despair in the oil segment will reduce electricity demand. While management points out that its economic base is more diverse than during the last downturn in the oil sector, a flattening of demand during these stressful times should not be unexpected. Underlying residential customer count growth has been around 2% compounded over the past 25 years, which is high for an electric utility. Houston Electric services 2.3 million customers and has a $4.1 billion rate base. CNP spends around $820 million a year on its electric capital expenditure budget, of which 37% is in transmission and 59% in distribution. Houston Electric’s current allowed return on equity is 10.0%, in line with the industry. The company has been granted a $13 million rate increase as of September with an additional $20 million pending decision. Regulated natural gas utility assets generated 26% of reported operating 2014 income, or $288 million. CNP services 3.3 million natural gas customers in five states, has a rate base of $2.2 billion and a capital expenditure budget of around $525 million. The average allowed return for the natural gas business is 10.3%. Last August, CNP requested $53 million in rate relief from its Minneapolis customers. Morningstar’s analysis recaps the positive and negative investment thesis for CNP: “Bulls Say: Strong utility earnings growth and solid cash distributions from Enable should allow approximately 4% annual dividend growth during the next five years. The formation of Enable will allow CenterPoint to focus capital expenditures on its utilities, resulting in an estimated 9% rate base growth during the next five years. Houston Electric’s service territory is located in one of the most economically vibrant metro areas in the country with annual customer growth averaging 2%, driving strong energy usage growth.” “Bears Say: The Transmission and Distribution segment’s operating earnings have recently benefited from abnormally high transmission right-of-way revenues. These revenues likely peaked in 2013 and likely will drop sharply over the next several years. Profitability in the competitive natural gas sales and service business remains challenging, with low basis differentials and severe competition. Low commodity prices and reduced gathering activity continue to pressure earnings from the pipelines and field services infrastructure serving dry gas regions. This will be a headwind for Enable.” Earnings per share have been under pressure from weakness in the Midstream Investments segment. Last year, CNP earned $1.20 a share, but current guidance is for $1.00 to $1.10 in 2015. The Utility segment is expected to contribute $0.71 to $0.75 a share with the balance $0.25 to $0.35 from Midstream Investments. These compare to 2014 adjusted earnings of $0.77 and $0.44, respectively. Based on a turn in its midstream business, management forecasts annual EPS and dividend growth at 4% to 6%, in line with other regulated utilities. Investors should take the time to review CNP’s free cash flow numbers. Over the past three years, CNP has generated higher operating cash flow than its capital expenditure budgets, accumulating $1.585 billion in free cash flow from 2011 to 2014, and $328 million for the trailing 12 months as of June 2015. CNP has produced positive free cash flow in five out of the previous 10 years. There are few utilities consistently generating positive free cash flow. Return on invested capital (ROIC) has historically been higher than utility industry averages at between 6.3% and 8.5% over the previous 10 years. The current weakness of its Midstream Investment business and the cautiousness investors are taking to the company is evident in the current valuation matrix. Based on previous 5-year averages, CNP offers value investors a reason to take notice. Below is a table of current valuation ratios, 5-year averages of the same, and an equivalent share price based on these averages: Ratio Current 5-year Avg Equivalent Price Price/Earnings 15.2 20.2 $ 24.58 Price/Book 1.8 2.2 $ 22.61 Price/Cash Flow 4.4 5.7 $ 23.96 Dividend Yield 5.3% 4.1% $ 24.39 Source: Morningstar.com, Guiding Mast Investments According to Morningstar, the current sum-of-the-parts valuation is in the $23 range. Estimates by segment would be $7 a share for Midstream Investments, $10 for Houston Electric and $6 for the natural gas distribution business. With a current price of $18.50, the spread is around $5, or 27%. Analysts are all over the board with their recommendation. According to finviz.com, the most recent analysis from Morningstar is 4 Stars, S&P Capital IQ is 2 Stars, Goldman reduced CNP to Sell, Credit Suisse recently upgraded CNP to Neutral from Underperform, Deutsche Bank is at Hold, Argus is at Buy, RBC Capital Markets lists CNP at Outperform, and Barclays’s is at Equal weight. Investors can take their pick: Buy, Hold, or Sell. CenterPoint’s diversified asset base could be of interest to larger utilities. The recent trend of electric utilities expanding by adding natural gas regulated utilities and by purchasing natural gas infrastructure to support expanding natural gas power generating facilities may favor CNP’s business profile. Midstream Investments focus has a strong Anadarko basin footprint covering a number of key active plays, including the SCOOP, STACK, Cana Woodford, Cleveland Sands, Tonkawa, Marmaton and Mississippi Lime plays. Other important midstream fields include Haynesville, Ark-La-Tex and Arkoma, and the Bakken. Electric utilities looking for long-term natural gas supply from these mid-continent areas could be interested in securing the infrastructure, hence CNP’s ownership of midstream assets could be of interest, along with CNP’s regulated natural gas customers. While there are no rumors of pending interest, the current consolidation trend is very powerful in the utility segment and at an enterprise value of $9.6 billion in equity ($23 times 425 million shares) and assumption of $8.6 billion in debt, a deal could be very financeable. With a current dividend yield of 5.3%, long-term utility and income investors are being paid to wait for a turn in the midstream business or for CNP to be active in the utility consolidation trend. CNP is a good example of stock valuations where investor anxiety is offering a Petri dish of opportunities. If CenterPoint is not on your radar screen to buy on further dips, it should be. Author’s Note: Please review disclosure in Author’s profile.