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Dynegy: A Growth Story About To Begin

Dynegy has mainly expanded inorganically through acquisitions. Substantial free cash flow generation and margin improvement are preparing the way for upside. Be on the lookout for any dips on which to buy Dynegy’s shares. Small cap companies offer investors the benefit of potentially increased returns with the downside of increasing volatility and/or risk in the investor’s overall portfolio. This risk can be mitigated through the inclusion of large cap and mid cap stocks as well as diversification through the purchasing of stocks of many small cap companies. Another way to increase the stability of these small cap investments is to make these investments in industries that are more stable, such as utilities and/or industrial industries. These industries retain their stability through inelastic consumer and/or firm demands as well as diversification across multiple other industries. With the infusion of small cap status into a firm in these industries, investors can benefit from the growth of the small cap in addition to the stability that comes with being in steady industry. Small cap utilities companies are one such combination of capital appreciation and capital preservation. Dynegy Inc. (NYSE: DYN ) is one such company that possesses these two characteristics, and based on investor sentiment, the shares are essentially up for grabs. The company owns a series of power generating facilities across the Midwest, Northeast, and West coast regions on the United States, so the company is mostly specialized in terms of customer concentration. The company diversifies its energy facilities across multiple utilities submarkets, including coal and gas; this adds the benefit of indirect additional diversification to investors in that investors who purchase the company’s shares get that indirect diversification. Some of the company’s major business segments include its Homefield Energy segment and its Dynegy Energy Services business. From looking at the company’ stock chart, investors can see that the company’s shares have gone on a bit of a roller coaster over the past few years. Capital invested at the beginning of calendar year 2013 would have generated essentially a zero percent return on investment throughout 2015. The shares have gone from a low of about $17 all the way to a high of about $36, and the shares have fallen all the way down again, so the shares are a bit volatile. In technical terms, the 50-day moving average has danced around the 200-day moving average, with the former going above and below the latter multiple times throughout the course of the past three years. Most recently, the 50-day moving average has once again dipped below the 200-day moving average, which could indicate near-term downside, as the spread between the two indicators seems to be widening. (click to enlarge) Source: Stockcharts.com From a fundamental perspective, the company is in a solid financial position: liquidity ratios indicate that the company’s financial health is in good order. The current ratio, quick ratio, financial leverage ratio all have hit all-time highs. However, it also appears that the debt to equity ratio has also hit an all-time high as well, with the ratio at about 2.5. The reason for this is because of the way the company grows. The company has expanded mainly through inorganic growth, and it has accomplished this by using a substantial amount of debt to fund its acquisitions. Some of its more recent acquisitions include the acquisition of Duke Midwest for $2.8B , which is extremely large for a company with a market cap of just under $3B. Although this particular method of growth has worked for the company, the fact of the matter is that the company’s capital structure has changed to include about 75% debt, which is certainly a lot. Thus, as the number of financial covenants begins to mount up, the company will become limited in the activities it can conduct, including further acquisitions. The company will have to be careful to ensure that the amount of debt that it takes off will not cripple its operations. Positive aspects of the company is that it has been generating large amounts of free cash flow recently, which the company can either use to reinvest back into the company or distribute it to shareholders in the form of share buybacks or dividends. In fact, the company began a share buyback program for $250M, which the company has already completed half of, so it appears that the company is committed to keeping shareholders happy. The amount of free cash flow that the company has historically generated has been negative, so this is definitely a positive trend for the company. Furthermore, cost reductions have resulted in margins that are beginning to stabilize, which could also boost free cash flow in the mid-term. All-in-all, it appears that the company has an uncertain future. However, the shares have dipped all the way back to their original price in 2013, so now could be a good time to buy. The fact that the company’s margins are getting better and that the company is beginning to generate substantial free cash flow is always a good sign. Be on the lookout for any further share dips to buy on.

Black Hills Corporation: A Stability And Growth 2-For-1

Black Hills Corporation’s shares have become undervalued as a result of its oil and gas exposure. A healthy dividend yield and stable diversified cash flow streams make the Company an excellent anchor for investors. The oil and gas business segment is a free call option if the industry recovers. For a mixture of stability and growth, investors should snap up Black Hills’s shares. Utilities companies are some of the most stable companies in existence due to their inelastic consumer demands. Even during economic downturns, consumers will not save money by cutting off their water or heat; they will save money through other means. As a result, the cash flow is always running high for utilities companies, and by the same token, investors can always depend on a steady cash flow (in most instances). Utilities companies are what we might consider as defensible investments, in which investors invest in them to “defend” their investments against loss during economic downturns. However, as investors know, small cap companies offer investors higher-than-expected growth when compared against the S&P 500 and other similar market-wide indices. This is because small cap companies have more room to grow than their large cap counterparts. As such, investors’ capital has more room to grow with the growth of the small cap firms. Thus, when investors combine small cap growth with the stability of utilities companies, they get a hybrid small cap utilities company that can offer the best of both worlds: a medium to low-risk, medium-reward investment that can both generate capital appreciation with the added benefit of capital preservation and a steady quarterly paycheck that the company puts in your bank account. One small cap utilities firm, Black Hills Corporation (NYSE: BKH ), offers this opportunity for investors to simultaneously benefit from capital appreciation and capital preservation. Black Hills Corporation is a diversified utilities company that runs a variety of regulated electric and gas utilities subsidiaries. The Company serves customers in the Midwest and Rocky Mountain states, so the Company is specialized in a certain region. Black Hills Corporation’s business segments can be divided into three main segments: Power Generation, Coal Mining, and Oil & Gas. The Company has both cash cow businesses and high growth businesses, which is always a great way for investors to get in on that stable cash flow and share value growth. From just the stock chart, investors can see that the Company has returned a healthy return to investors: capital invested in the Company at the onset of 2011 has generated a return on investment of about 75%. Keep in mind that this number does not include dividends that the Company generates for shareholders. With a dividend yield of about 3%, the dividends add a substantial amount of return on top of the pure capital appreciation return. While it appears that the stock price has begun to stagnate and even slowly slip, that is more of a result of macro conditions than anything else-it is not Company-specific. Furthermore, the Company has oil and gas exposure, which has resulted in the Company feeling some of the pain from the collapse of oil prices a few years back. However, because the Company is diversified in several sub-industries, the Company has only suffered a little. From a technical perspective, the 50-day moving average has swung alongside the 200-day moving average for quite some time-the two continuously move back and forth. Most recently, the 50-day moving average has been below its bigger brother, but it appears that the spread between these two indicators is closing, which could indicate near-term upside. (click to enlarge) Source: Stockcharts.com From a fundamental perspective, what investors are looking at is an undervalued, cash-flow generating Company that has suffered from the setbacks in the oil and gas industries. Black Hills Corporation has its hands in a variety of submarkets within the utilities industry, including oil and gas, coal, electricity, and some other markets. The cash cow generating businesses include its Power Generation and Coal Mining businesses. These businesses provide ample cash flow for the Company to inject back into the Company for further growth and for the Company to return to shareholders as dividends. The fast growth segment is the Oil & Gas segment, which has been dealt a blow as a result of the collapse of oil prices. However, it is this segment that essentially gives the shares a free call option. This segment is subject to the volatility seen in the larger oil and gas industry, and this can be viewed as a negative. At the same time, it is important to remember that this greater volatility can swing the shares in the positive direction as well. Thus, Black Hills Corporation has a number of aspects that investors will find favorable. A strong dividend yield, excellent stable cash flows from diversified business segments, and a free call option in case the oil and gas industry recovers (which it probably will-the question is more when than if it will) all make the Company an excellent investment for long-term investors.

Targeting 35% Upside For The AES Corporation

Summary We are adding the AES Corporation to our “buy” list. Both the fundamental and technical analyses indicate a potential for a 35% gain over the next few years. The key risk is our assumption that cash flows do not materially deviate from their long-term uptrend. Introduction The AES Corporation (NYSE: AES ) has been exposed to a number of headwinds recently, most notably falling energy prices across the globe, rapidly appreciating U.S. Dollar and weak demand coming from the emerging markets, particularly Brazil, Argentina and Colombia. The most recent negative surprise was the Q3 revenue miss of as much as $1.5bn, which prompted the management to revise down their 2016 earnings guidance below analyst estimates. Cost cutting measures have been put forward to offset the macroeconomic headwinds by 2018 and we see them as a necessary adjustment. It is difficult to judge whether they work out as planned, but it is encouraging to see that the leadership is taking the appropriate steps to keep the business viable. Furthermore, Andres Gluski (the CEO) emphasized their focus on free cash flow as a source of shareholder value, and we believe that this is an appropriate measure for estimation of AES Corporation’s long-term investment value. Valuation Our valuation model for AES is based on the company’s ability to generate cash. The key measure of cash flows that we use is free cash flow, which is the total cash inflow from operations minus the dividends and capital expenditure outlays. This is effectively the amount of “excess” cash that the company is making and therefore accruing to its lenders and shareholders. While we do look at historic cash flows, cash flows projections are of crucial importance because markets are forward looking. Our estimated cash flows for the next 10 years are simply based on the previous trend, as we do not have access to analyst estimates for AES. After 10 years, we assume that the growth rate of cash flows falls back to its previous trend and remains on it for the next 10 years, after which it normalizes towards the sustainable rate of 3.9% per annum, based on the average real GDP growth over the last 15 years and the average inflation rate of 2%. The chart below shows the historic (blue line) and projected free cash flows (red line). (click to enlarge) To calculate the total value of the firm, we discount the projected cash flows and the company’s terminal value by its weighted average cost of capital ( OTC:WACC ). Our estimate of AES’s cost of debt is 7.28%, based on their interest expense and amount of debt outstanding in the last fiscal year. The cost of equity is calculated using the 10 year treasury yield as the “risk-free” proxy plus the implied equity risk premium of 9.13% times the historic beta of 1.1675 for the stock. Some of the other key metrics summarized below: •Beta = 1.17 •ERP = 5.98% •Cost of Debt = 7.28% •Cost of equity = 9.13% •Debt to Assets = 54.45% •WACC = 7.73% •Current Price = $9.9 •Fair Price = $26.52 (167.9% return) After discounting the projected free cash flows and the company’s terminal value in 10 years’ time, we subtract the current value of debt and arrive at the total equity value of 17,887,985, which equates to $26.52 per share. With today’s share price at $9.9, re-pricing towards the estimated fair value would require a return of 167.9%. The green line in the below chart represents the estimated “fair value” per share, with the dashed lines showing the upper and lower bounds of the confidence interval based on stock’s volatility. (click to enlarge) Relative Valuation American Electric Power Company (NYSE: AEP ), Pinnacle West Cap. (NYSE: PNW ), Firstenergy (NYSE: FE ), Nrg Energy (NYSE: NRG ), Consolidated Edison (NYSE: ED ), Cms Energy (NYSE: CMS ), Dte Energy (NYSE: DTE ), Entergy (NYSE: ETR ), Nextera Energy (NYSE: NEE ), Dominion Resources (NYSE: D ), Xcel Energy (NYSE: XEL ), Exelon (NYSE: EXC ), Ppl (PP and), Pg&E (NYSE: PCG ), Pub.ser.enter.gp. (NYSE: PEG ), Edison Intl. (NYSE: EIX ), Southern (NYSE: SO ), Teco Energy (NYSE: TE ), Pepco Holdings (NYSE: POM ), Eversource Energy (NU) are AES’s closest peers within the S&P 500. The table below can help us understand AES’s valuation in relative terms. Table 1: Relative Valuation Table, S&P 500 peers AES AEP PNW … Median Lower Quartile Upper Quartile PE 11.60 15.10 17.20 … 16.90 13.23 20.50 PC 2.48 6.31 6.33 … 6.31 4.81 6.83 PB 1.63 1.58 1.57 … 1.61 1.56 1.75 ROE 17.02 10.13 9.46 … 10.13 9.08 11.51 EPS Growth (5 year) -1.03 2.39 39.79 … 1.03 -1.73 6.80 Beta 1.17 0.58 0.72 … 0.59 0.55 0.69 AES Corporation benefits from very low price multiples, which indicates that the bad news are already in the price. price to earnings ratio of 11.6x is below the lower quartile for the group (13.2x). The same is the case for the price to cash flow and price to book multiples, currently standing at 2.5x and 1.6x, respectively. (click to enlarge) Even more importantly, the price to book ratio of 1.6x looks very attractive in the context of the return on equity of 17.0%. The chart above shows that this makes the company look significantly undervalued relative to peers, given the current industry relationship between this price multiple and underlying profitability. The stock looks attractive from the technical perspective as well. While in the short term the price could fall to as low as 8.6%, a failure to break below this level would confirm the wedge-like formation in play, targeting roughly 35% upside, depending on the timeframe. While a potential break below the support would imply further short term weakness, we see current price as an opportunity to buy due to the 2.5 times greater upside. Of course, if rate hikes in the U.S. push the U.S. dollar higher, investors will need to exercise more patience until the target is reached. (click to enlarge) Conclusion In summary, the company leadership has already taken action to counter the unfavorable impact of macroeconomic developments across the globe. The cost cutting measures that are aiming to support the free cash flow generation through 2018 may or may not work as planned, but investors should focus on risk management and diversification rather than crystal ball gazing. Our discounted cash flow model indicates roughly 35% upside (the lower end of the fair value range, the conservative target), which is also supported by long-term technicals. AES Corporation looks significantly undervalued relative to peers as well, thereby ticking all our boxes. As a result, we are adding this stock to our “buy” list today.