Tag Archives: tristan-r-brown

Southwest Gas: A Weak Service Area Economy Snaps A Multi-Year Earnings Growth Streak

Summary Southwest Gas saw its earnings growth streak snapped last year by a weakening service area economy. The company’s share price rebounded recently as market volatility has pushed investors into defensive stocks such as utilities. While its historical performance is impressive, continued signs of weakness in its service area threaten to dampen future earnings growth for the company. Given the company’s relatively low forward dividend yield and lack of clearly undervalued shares, I recommend that investors seeking to reduce their volatility look elsewhere in the sector. Natural gas utility and construction service provider Southwest Gas (NYSE: SWX ) welcomed Q3 with a rebounding share price following a 17% decline in the first half of the year (see figure). While the company’s earnings have faltered of late, most recently with a Q1 earnings miss, much of its share price’s poor performance can be attributed to the prospect of U.S. interest rates being increased by the Federal Reserve for the first time in almost a decade. By contrast, Q3 to date has been beset by volatility arising from the high likelihood of an imminent “Grexit” and China’s recent stock market crash, both of which have driven investors back to bonds and utilities. Southwest Gas is finding its own earnings outlook under pressure due to slowing economic growth in much of its service area. This article evaluates the company as a potential long investment in light of these recent conditions. SWX data by YCharts Southwest Gas at a glance Operating as a public company since 1956, Nevada-based Southwest Gas provides natural gas and related services to its 1.9 million customers located in Arizona, Nevada, and eastern California. It has expanded significantly in recent decades and is now the largest natural gas provider in Arizona and Nevada. The company’s operations are split into two business segments. Its natural gas operations, which are regulated, generate approximately 87% of its consolidated earnings via transmission and distribution services. While the segment supplies natural gas to a wide customer base, with 53%, 37%, and 10% of them located in Arizona, Nevada, and California, respectively, 99% of them are residential and commercial in nature. Likewise, the segment generates most of its operating margin from Arizona and Nevada (56% and 34%, respectively). The second segment, named Centuri, which expanded last September following $185 million worth of acquisitions , provides construction services. This segment is divided between four construction subsidiaries: NPL construction, which installs underground piping, mostly in the western U.S.; Link-Line Contractors, which is a Canadian natural gas distribution contractor; W.S. Nicholls Construction, which engages in industrial construction projects in Canada; and Brigadier Pipelines, which installs midstream pipelines, primarily in Pennsylvania. While Centuri is a relatively small contributor to the company’s consolidated earnings, the firm believes that it has substantial growth opportunities due to demand for natural gas pipelines and distribution infrastructure in the wake of the advent of shale gas. Southwest Gas experienced strong earnings growth in the aftermath of the Great Recession as inexpensive shale gas and growing population in its service area drove consumption. Its annual diluted EPS increased by 38% between FY 2010 and FY 2013, although it declined slightly in FY 2014. This earnings growth in turn drove regular dividend increases, and the company’s annual dividend has increased by 62%, or a 10.1% CAGR, since FY 2010. The most recent increase came in the form of an industry-beating 11% boost that was announced earlier this year. Investors not surprisingly responded very positively to this record of earnings and dividend growth, pushing the company’s share price up by almost 100% between January 2011 and January 2015, handily beating the sector indices (see figure). Investors have lost some of their enthusiasm for the firm of late, however, following a disappointing Q1 earnings report and broader bearish sentiment across the utilities sector. SWX data by YCharts Q1 earnings report Southwest Gas reported a mixed bag of earnings for Q1 in May, beating on revenue but missing on EPS. Revenue came in at $734.2 million, up an impressive 20.7% from $608.4 million the previous year and beating the analyst consensus by $67.3 million. Several factors contributed to this YoY increase, including the company’s addition of 26,000 natural gas customers (an increase of 1.4%) over the trailing twelve months and the reporting of revenues from its construction services acquisitions (the latter resulted in a $30 million increase to revenue). The company’s natural gas operations segment did particularly well, increasing its revenue by 14% YoY, although this was mostly offset by a substantial increase to its cost of gas sold. Operating income rose slightly to $129.6 million from $127.1 million, with a $7.4 million increase by the natural gas segment being mostly offset by a $5 million decrease by the construction segment. The increase to the former was primarily driven by regulatory rate relief while the latter was hurt by a combination of poor weather conditions in its service area (Canada is not hospitable to Q1 construction work even in the best of times, which this year’s especially cold quarter was not). Integration expenses associated with last year’s acquisitions also hurt the construction segment’s operating income compared to the previous year, although these can be expected to decline in coming quarters. The company’s consolidated net income rose by 1.7% YoY from $70.8 million to $72.0 million (see table). Diluted EPS came in at $1.53 compared to $1.51 the previous year, missing the consensus estimate by $0.07. The natural gas segment did especially well, increasing its net income from $72.6 million to $78.9 million. The gain was the result of a higher operating margin resulting from the aforementioned rate relief and lower O&M expenses. The construction segment reported a net loss that widened from $1.8 million in FY 2014 to $6.9 million in the most recent quarter, with the poor performance being attributed to acquisition expenses and a required loss reserve of $5 million on one of its industrial projects. Southwest Gas Financials (non-adjusted) Q1 2015 Q4 2014 Q3 2014 Q2 2014 Q1 2014 Revenue ($MM) 734.2 627.7 432.5 453.2 608.4 Gross income ($MM) 129.6 112.4 18.3 26.8 127.1 Net income ($MM) 72.0 58.7 2.0 9.6 70.8 Diluted EPS ($) 1.53 1.25 0.04 0.21 1.51 EBITDA ($MM) 199.3 185.4 80.3 88.9 191.6 Source: Morningstar (2015). Southwest Gas reported a couple of regulatory developments from Q1 that will likely affect its future earnings. It received approval from California regulators for a $2.5 million margin increase that was established at the beginning of the year. It also received approval from Nevada regulators for the replacement later this year of $14.4 million worth of vintage plastic pipes with safer contemporary versions. Finally, it received preliminary environmental approval from federal regulators for a $35 million pipeline expansion project. Finally, the company’s management stated during its Q1 earnings call that it was not impacted by the extraordinary drought conditions in California during the quarter and does not expect this to change in coming quarters. While not surprising given the company’s focus on natural gas distribution rather than, say, hydroelectric generation, it is still good news for its investors. The company’s balance sheet ended the quarter in solid shape with $38.0 million in total cash and a current ratio of 1.1. It had very little short-term debt at $18.3 million and $1.5 billion in long-term debt, the latter down $131 million from the previous quarter. With a debt rating from the S&P 500 of BBB+ and a stable outlook, the company should have little difficulty financing its planned capex. Furthermore, management intends to increase the company’s dividend payout ratio from its current value of 48% closer to the industry average (68% TTM as of Q1 ), indicating that it has substantial room to increase if permitted by earnings growth. Outlook Management was comfortable enough with its results despite the earnings miss to reaffirm its full-year guidance during the earnings call. Population growth in the service area is expected to lead to 1.5% natural gas customer growth, a slightly higher rate than was reported the previous year. This in turn is expected to lead to operating margin growth of 2% despite higher assumed operating and pension costs, the latter resulting from the adoption of new mortality tables reflecting longer life expectancies. More importantly, the company expects to incur capex of $445 million in FY 2015, up from $315 million in FY 2013 and $350 million in FY 2014, with the increase driven by the replacement of existing infrastructure (such as the aforementioned vintage pipes) and an expansion of its service area. Beyond this year, the company expects to incur a total of $1.3 billion in capex through FY 2017. This spending will be driven by multiple investments, including a liquefied natural gas [LNG] storage facility that has received pre-approval from Arizona regulators and is expected to be operational within 30 months of receiving final approval. As with the aforementioned pipeline expansion, these investments will support the company’s rate base increase proposals in the coming years, ideally providing further room for earnings and dividend increases in the process. Future customer growth and natural gas demand will depend in large part on the economic health of the company’s service area, the outlook of which has dimmed recently. The unemployment rates of Arizona, Nevada, and California have fallen well below their post-recession highs but, despite this, all three remain above the U.S. average (see figure). Worse, Nevada’s rate has actually held steady at 7% over the last two quarters and, according to a recent report , fully 33% of the state’s population lives in “economically distressed communities,” making it the most distressed state in the U.S. Worse, its rate of employment growth in Q1 fell from 3.8% last year to 2.8% this year. Arizona, from which Southwest Gas derives the majority of its customers, has the third-highest unemployment rate in the country if underemployed workers are also counted. While its employment rate grew in Q1 compared to the previous year, it still only managed to achieve a measly 2.6%. Arizona and Nevada, which are together responsible for the majority of the company’s operating margin, have achieved slower GDP growth over the last several years (see second figure). Southwest Gas will struggle to reverse its declining ROE, both from its natural gas operations and its consolidated operations, so long as its service area economy remains weak, mitigating the advantage conferred by its relatively favorable ROEs allowed by regulators. Arizona Unemployment Rate data by YCharts Arizona Change in GDP data by YCharts Valuation The analyst estimates for Southwest Gas have declined over the last 90 days in response to its Q1 earnings miss. The FY 2015 and FY 2016 consensus estimates have declined from $3.18 and $3.39 to $3.14 and $3.35, respectively. Based on the company’s share price of $54.86 at the time of writing, its shares are trading at a trailing P/E ratio of 18.6x and forward FY 2015 and FY 2016 ratios of 17.5x and 16.4x, respectively. All three of these ratios have declined substantially, although the forward ratios would need to fall to roughly 15x for the company’s shares to be considered undervalued based on their historical valuations (see figure). SWX PE Ratio (TTM) data by YCharts Conclusion Natural gas utility Southwest Gas has been one of the sector’s better performers in recent years, benefiting from cheap natural gas and customer growth. While its records of sustained earnings and dividend growth make the company look attractive from a historical perspective, economic and employment growth in its service area have faltered in recent quarters. Furthermore, earnings growth aside, the company has reported declining ROEs over the last three fiscal years, which is a trend that it will struggle to reverse so long as its service area’s economy remains weak. At this time, its construction services segment is too small to be likely to offset the natural gas segment’s declining ROE in the next year or two, although its individual multi-year growth potential should be noted. I am not bearish on the firm and believe that it could outperform the broader market, especially if China’s market volatility and a looming Grexit cause investors to move toward defensive stocks. That said, in the absence of a compelling argument that its shares are undervalued (defined here as a share price below $47, or 13x estimated FY 2016 earnings), I recommend that potential investors look instead at those utilities firms with superior earnings growth prospects and dividend yields such as IDACORP (NYSE: IDA ), Alliant Energy (NYSE: LNT ), or DTE Energy (NYSE: DTE ). Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

IDACORP: Dividend Investors Shouldn’t Overlook This Idaho Utility

Summary Idaho electric utility IDACORP will likely see its earnings growth streak snapped this year due to a warm Q1 and drought conditions in its service area. The company’s earnings should still be strong, however, due to its record of achieving high ROEs and solid economic growth in its service area. While its shares are not undervalued at this time, headlines about the effects of a strong El Niño later in the year could make IDACORP’s forward valuations more attractive. Shares of Idaho-based regulated electric utility holding company IDACORP (NYSE: IDA ) have fallen sharply in value since the beginning of the year, marking their largest such decline in at least five years (see figure). The drop has coincided with the presence of severe drought conditions in the Western U.S., including in much of the company’s service area, that have substantially reduced its hydroelectric output. While the company’s annual earnings are now expected to fall on a YoY basis in FY 2015 for the first time in almost a decade as a result, it remains a solid firm with good dividend growth potential. This article evaluates IDACORP as a potential long investment in light of these conditions. IDA data by YCharts IDACORP at a glance IDACORP operates in the regulated and non-regulated electric utility sector via its two primary subsidiaries, Idaho Power Co. and Ida-West Energy. It also operates IDACORP Financial, which oversees non-regulated, non-utility investments in affordable housing projects and tax credit-earning historical rehabilitation projects. Its main segment Idaho Power, however, is a regulated electric utility that generates and distributes electricity in Idaho and east Oregon. Idaho Power provides electricity to nearly 516,000 customers via 3,594 MW capacity. This capacity consists of a mix of renewable and fossil facilities, including 48% hydroelectric, 31% coal, and 21% natural gas. It also provides an additional 2,842 thousand MWh of electricity from wind, biomass, and other renewables via long-term purchase power agreements. Finally, Ida-West is a non-regulated electric utility that owns 50% equity stakes in nine hydroelectric projects in Idaho and California with a combined generating capacity of 44.6 MW. Ida-West formerly also engaged in project development, although it is now a pure-play electric utility. IDACORP has benefited from robust electricity demand in its service area and favorable regulatory schemes, generating 7% annual earnings growth since FY 2010. The combination of this earnings growth and the regulatory schemes has allowed it to report annual ROEs of roughly 10% each year since FY 2011, easily topping the industry average. Furthermore, the company has also managed to top its median EPS annual guidance since FY 2010. Not surprisingly, given its financial performance, the company’s dividend has also steadily grown. Following a large 9.3% increase to its quarterly dividend in Q3 2014 that brought it up to $0.47/share, or a 3.2% forward annual yield, the company has increased its quarterly dividend by 57% since Q4 2011, resulting in a payout ratio of 48%. Rather surprisingly, given this performance, the company is very undercovered, with almost a decade passing since it was last the subject of an article on Seeking Alpha and only two analysts joining the most recent earnings call . Q1 earnings IDACORP reported its Q1 earnings at the end of April. Its revenue declined by 4.5% YoY from $292.7 million to $279.4 million. Management attributed the fall to the presence of warm weather during the quarter, with 13% fewer heating degree days than Q1 2014 and 15% fewer heating degree days than the long-term average. This was partially offset by customer growth, with the total number of customers rising by 1.6% over the trailing twelve months as of the end of Q1. Operating income fell to $42.9 million from $48.6 million the previous year. While the increased number of customers increased the most recent result by $1.9 million. This was more than offset by increases to depreciation (up $1.2 million) and O&M (up $3 million). Neither of these increases were necessarily negative to the company’s long-term outlook, however, as the former was the result of a $170 million increase YoY to net PP&E while the latter was scheduled to occur in Q2 before being moved up in response to slack Q1 demand. Net income fell from $27.4 million to $23.4 million YoY (see table). Diluted EPS came in at $0.47, down from $0.55 and missing the analyst consensus by $0.11. While substantial, the miss was due to the warm Q1 weather, which resulted in an EPS hit of $0.05, and the O&M increase, which reduced it by another $0.06. Suffice to say that the weather is outside of the company’s control while the maintenance costs would have been incurred in Q2, so excluding these two effects, the company’s earnings were in line with expectations. Operating cash flow ultimately increased YoY by $8.5 million to $105.4 million due to the impact of a cost adjustment mechanism on the company’s power supply costs. IDACORP Financials (non-adjusted) Q1 2015 Q4 2014 Q3 2014 Q2 2014 Q1 2014 Revenue ($MM) 279.4 289.8 382.2 317.8 292.7 Gross income ($MM) 177.2 183.4 240.7 211.7 178.6 Net income ($MM) 23.4 34.6 86.9 44.5 27.4 Diluted EPS ($) 0.47 0.69 1.73 0.89 0.55 EBITDA ($MM) 84.9 74.3 154.7 115.1 89.8 Source: Morningstar (2015). IDACORP ended the quarter with $317.2 million in total cash, up from $56.8 million QoQ and $88.3 million YoY. The increase was driven by the strong operating cash flow and a decision by management to pay off $120 million of debt yielding 6% and maturing in FY 2018. This was replaced by $250 million of debt yielding 3% and maturing in FY 2045. In addition to increasing the company’s cash reserve and greatly extending the horizon of its total debt, this move also reduces its annual interest expense by a net of $2 million. At the end of Q1, the company had no long-term debt due before 2019, with most of it not requiring full repayment until after 2032. Outlook Management reaffirmed its FY 2015 diluted EPS guidance range of $3.65 to $3.80 during the Q1 earnings call, with the Q1 miss being offset by the timing of the O&M expense and a $5 million tax benefit resulting from the aforementioned debt refinancing. It did, however, reduce its hydroelectric output guidance for the year down from 7-9 million MWh to 5-7 million MWh due to the warm Q1 weather and reduced snowpack levels. This raises the question of whether or not investors should expect the Q1 weather to have been a one-time event that will be offset by more favorable conditions in the future. While the persistence of extreme drought conditions in California has received the bulk of public attention this year, several of IDACORP’s hydroelectric facilities in Idaho and on the Oregon border are in counties experiencing severe and extreme drought conditions. The Snake River basin, for example, was determined by Washington back in April to be at or below 75% of its normal water supply. Worse, the Snake River’s streamflow is expected to remain below 50% of its normal flow through the end of this summer. The possibility of El Niño conditions manifesting themselves later this year has the ability to further complicate IDACORP’s outlook, at least as far as weather is concerned. While a strong event would result in wetter weather for California, a NOAA analysis from the 1990s determined that winter precipitation in Idaho fell by as much as 20% on average during past events. Worse, El Niño conditions are also associated with warmer winter temperatures . Q4 2015 and Q1 2016 could therefore see both reduced demand as well as reduced hydroelectric generation in IDACORP’s service area compared to previous years. The good news for the company’s investors is that it is asking state regulators to use a weather-normalization mechanism that would smooth out fixed cost collection, mitigating the effects of extreme weather events on the company’s earnings. Furthermore, the company still has $45 million of accumulated deferred investment tax credits that can be used to achieve an annual ROE of 9.5% in Idaho in the event that pre-tax earnings fall short of this rate. These two safeguards should prevent another low-demand, low-output winter from having a major impact on the company’s earnings, although an especially strong El Niño would likely still cause it to miss the consensus for Q4 2015 and/or Q1 2016. Weather aside, however, IDACORP continues to benefit from its service area’s strong economy. Idaho’s unemployment rate is well below the U.S. average (see figure) while that of Oregon has improved of late. Management reported during the earnings call that it is seeing 4% unemployment in its service area, below the U.S. average of 5.3%. Idaho’s economic outlook has also improved of late, and the service area’s GDP is now expected to reach as high as 3.8% in FY 2015, up from January’s estimate of up to 3.5% for the year. NOAA is forecasting for Q3 to be both wetter and warmer than average in Idaho, conditions that would boost hydroelectric supply and electricity demand. Looking further ahead, the company is investing in new interstate transmission lines that, combined with maintenance, are expected to incur capital expenditures of $1.5 billion through 2019. This, combined with the existence of low rates for customers at present (as much as 20% below the national average), should provide the company with substantial leeway from regulators in the event that weather conditions threaten its future ROEs. Finally, IDACORP’s management intends to increase its distributions to shareholders, as evidenced by the most recent dividend increase. A dividend payout ratio of 50-60% is being targeted, with increases of 5% or more being anticipated to achieve this range from the current ratio of 48%. Idaho Unemployment Rate data by YCharts Valuation The consensus analyst estimates for IDACORP’s diluted EPS in FY 2015 and FY 2016, which have remained unchanged over the last 90 days, are $3.72 and $3.81, respectively. While lower than in FY 2014, these numbers would still represent strong results for the company. Based on the company’s share price of $58.58 at the time of writing, its shares are currently trading at a trailing P/E ratio of 15.5x and forward FY 2015 and FY 2016 ratios of 15.7x and 15.4x, respectively. While a bit lower than the sector average, all three ratios are well above their respective 5-year lows (see figure), suggesting that its shares are not undervalued at present. IDA PE Ratio (TTM) data by YCharts Conclusion IDACORP will likely see its rapid earnings growth falter a bit in FY 2015, although the magnitude of this shift will ultimately depend on unpredictable weather conditions later in the year. Its long-term growth potential is still positive, however, and its dividend has room remaining for significant increases before the upper bound of management’s target dividend payout ratio range is achieved. The company’s strong record of impressive ROEs, steady earnings growth, and multiple dividend increases makes IDACORP an attractive investment option for those investors seeking exposure to utilities. Its shares are not undervalued at this time and value investors may find that the news of reduced precipitation levels and temperatures in the coming winter resulting from a strong El Niño end up reducing the company’s valuation still further. With that in mind, I would not hesitate to purchase its shares for under $50, or approximately 13x its FY 2016 earnings, especially if management’s efforts to mitigate its weather-related earnings impacts are successful. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

PNM Resources: Potential Headwinds Diminish A Compelling Value Argument

Summary Electric utility holding company PNM Resources has underperformed the S&P 500 in 2015 YTD due to regulatory and economic headwinds. While regulatory uncertainty is negatively impacting the company’s FY 2016 earnings estimates, its history of earnings and dividend growth provide some optimism. At the same time, however, its earning growth could be adversely affected by a slowing Texas economy and reduced energy demand in New Mexico. Potential investors should not consider initiating a long position until the company’s shares hit a 3-year forward P/E ratio low, or $21.40 based on the consensus FY 2016 EPS estimate. PNM Resources (NYSE: PNM ) is an investor-owned holding company that provides electricity to customers in New Mexico and Texas through two subsidiary utilities, PNM (in New Mexico) and TNMP (in Texas). The company’s share price grew strongly in the second half of 2014 as energy prices fell across the board but has subsequently lost almost of that ground in 2015, having fallen by almost 21% YTD (see figure). While the company’s trailing earnings have increased even as its share price has retreated, the presence of regulatory uncertainty and underwhelming electricity demand in New Mexico have weighed on investors’ minds. This article evaluates PNM Resources as a potential long investment in light of the current operating conditions. PNM data by YCharts PNM Resources at a glance The two utility subsidiaries of PNM Resources operate in different areas of the electric utilities sector. PNM (the subsidiary rather than the holding company) is a vertically integrated regulated electric utility that generates, transmits, and distributes electricity to 513,000 residential and commercial customers across New Mexico, including Greater Albuquerque. It owns and operates 2,707 MW of generating capacity and 14,800 miles of transmission lines. PNM also owned a gas utility until 2009, at which point it was sold to a competitor in New Mexico to allow the subsidiary to focus entirely on electricity generation and distribution. PNM has undergone the beginning of a transition toward lower-carbon energy sources in recent years in an effort to reduce its overall carbon footprint. This transition will involve the closure of two of PNM’s existing coal-fired generating units by 2017, a move that will reduce its total capacity by 847 MW while also bringing its greenhouse gas emissions 17% below their 2005 levels. PNM is also investing in the generation and purchase of renewable electricity, including the construction of 107 MW of utility solar capacity by 2016 for $269 million, the purchase of 102 MW of wind energy from the Red Mesa Wind Energy Center, and 10 MW of geothermal energy. One of the most notable investments is the PNM Prosperity Energy Storage Project , which is the first solar electricity storage facility to be fully integrated into the utility power grid. The project provides 500 kW of solar energy capacity and 1 MWh of electricity storage capacity. While the announcement of the Tesla Powerwall has sparked a debate into the current value of electricity storage, the placement of PNM’s project ensures that it will have the greatest feasibility available in terms of solar availability. PNM has not completely abandoned coal, however, having recently signed a coal supply agreement through 2022 with miner Westmoreland Coal (NASDAQ: WLB ) that will generate cost savings for the utility of up to 20%. TNMP is a regulated electricity transmission and distribution utility that provides electric service to customers in Texas. The electric utility in Texas is different from those in many other states in that it is unregulated at the point of generation but regulated for purposes of transmission and distribution. TNMP is regulated, therefore, but under the Texas Electric Rate program it distributes electricity to customers from competing retail electricity generators. TNMP serves 240,000 customers, including coastal petroleum facilities, via approximately 9,000 miles of transmission and distribution lines. PNM Resources has maintained relatively heavy exposure to New Mexico over the past several years, with PNM generating a greater share of the holding company’s earnings than TNMP. This has hurt its revenue of late due to weak electricity demand, the result of a combination of a weak economy and unfavorable weather conditions. The company’s revenue in FY 2014 was 16% lower than in FY 2010. Thanks to the combination of low energy prices following the widespread advent of shale gas extraction, which caused natural gas and coal prices to move sharply lower, and cost-control measures, the company has been able to maintain its gross income and operating income (see table). PNM Resources Financials (non-adjusted) Q1 2015 Q4 2014 Q3 2014 Q2 2014 Q1 2014 Revenue ($MM) 332.9 346.9 414.0 346.2 328.9 Gross income ($MM) 174.6 163.9 221.3 174.8 169.0 Net income ($MM) 14.3 19.0 55.7 29.1 12.5 Diluted EPS ($) 0.18 0.24 0.69 0.36 0.16 EBITDA ($MM) 111.7 120.7 174.9 130.5 104.0 Source: Morningstar (2015). PNM Resources has also been able to maintain a solid, if not exceptionally strong, balance sheet over the last several quarters (see table). Its current ratio has remained stable even as it has returned $50-60 million in cash dividends, which have in turn grown by approximately 12% annually per share, to shareholders. The most recent such increase came last December, bringing the quarterly dividend up to $0.20 per share. While the company’s cash reserves have generally been low, this is not uncommon for regulated utilities due to their access to large lines of credit at relatively low interest rates. PNM Resources Balance Sheet (restated) Q1 2015 Q4 2014 Q3 2014 Q2 2014 Q1 2014 Total cash ($MM) 122.4 28.3 28.4 12.1 27.2 Total assets ($MM) 5,939.3 5,829.3 5,709.2 5,604.2 5,507.0 Current liabilities ($MM) 693.0 704.3 700.3 486.9 312.1 Total liabilities ($MM) 4,224.9 4,107.8 3,986.5 3,907.7 3,841.2 Source: Morningstar (2015). Q1 earnings report PNM Resources reported Q1 earnings last month that were largely in-line with expectations. The company reported revenue of $332.9 million, up 1.2% from $328.9 million in Q1 2014 and just missing the consensus estimate by $2.1 million. The company’s loads were down in New Mexico overall (residential loads were higher YoY but commercial and industrial loads were lower), marking at least the ninth consecutive quarter in which such a drop was reported in the state. This was partially offset by higher loads in all categories in Texas, however; the company also reported better-than-expected customer growth in both states as well. The presence of low energy prices and other sources of income in Q1 allowed PNM Resources to report slight operating income growth YoY from $48.8 million to $49.6 million. Net income also increased, from $12.5 million in Q1 2014 to $14.3 million in the most recent quarter, or diluted EPS results of $0.16 and $0.18, respectively. Adjusted net income, which included positive adjustments from mark-to-market impacts of economic hedges and state tax credits, rose from $14.2 million to $16.5 million YoY. Adjusted diluted EPS came in at $0.21 compared to $0.18 the previous year, beating the consensus estimate by $0.03. PNM reported the strongest improvement over the previous year, with its EPS rising from $0.11 to $0.14 as refined coal income, reimbursement for spent nuclear fuel, and half-priced leases more than offset the negative impact of reduce New Mexico loads. TNMP reported a slight EPS increase from $0.09 to $0.10 YoY, with the increase being attributed to slightly higher Texas loads and rate relief. While Q1 is historically a weak quarter for utilities operating in the Southwest U.S., it was strong enough for PNM Resources to maintain its previous guidance for adjusted diluted EPS of $1.50-$1.62 in FY 2015. Outlook PNM Resources faces a mixed operating outlook over the next several quarters. The economies of Texas and New Mexico have undergone very different recoveries in the wake of the Great Recession despite their close proximity. While New Mexico was not especially hard-hit by the recession, with its unemployment rate staying below that of both Texas and the U.S. average initially (see figure), it quickly fell behind after 2012. Texas, on the other hand, saw its unemployment rate plummet beginning the same year as it became a major producer of natural gas and petroleum, and its unemployment rate remains well below those of New Mexico and the U.S. average despite a recent uptick following last year’s energy price collapse. This has allowed PNM Resources to essentially split the difference, although its heavier focus on New Mexico via electricity generation as well as distribution has prevented strength in Texas from completely offsetting New Mexico’s relative weakness in recent quarters. Management stated during the Q1 earnings call that it is seeing early signs of “stabilization” in New Mexico’s economy, with employment rolls increasing and YoY customer growth of 0.7%. This improved outlook is partially offset by weakness in Texas, however, as energy production in that state has fallen in recent months (although customer growth there did increase by 1.4% in Q1 YoY). Potential investors in PNM Resources will want to keep an eye on economic conditions in both states. While energy prices have rebounded of late, sustained low prices for natural gas and petroleum could limit load growth in Texas in particular, hampering the company’s outlook. Texas Unemployment Rate data by YCharts Regulatory uncertainty has increased recently following adverse initial decisions at both the federal and state levels. PNM Resources recently received notice that the compliance plans it had submitted to regulators were determined to be insufficient, raising questions as to the amount and timing of expenses anticipated under them. The first initial decision relates to the company’s BART determination under the Clean Air Act. Whereas the company has proposed to retire two of its coal-fired units and upgrade two more to comply, the BART hearing examiner recommended that the negotiated proposal be rejected. While the recommendation is not final, Moody’s has indicated that an adverse final BART decision would cause it to remove its positive outlook on the company’s debt, potentially resulting in the imposition of higher interest rates. PNM Resources has also encountered difficulties with its future rate case proposal, which a hearing examiner determined was incomplete. As a regulated utility the company’s rates are determined by regulators rather than the market, making the final decision an important one for the company’s earnings. While the hearing examiner’s decision is not final, its finalization by the state regulatory commission would delay the implementation of new rates by several months, negatively impacting the company’s earnings for one or more quarters. The company has already receive approval for transmission rates equaling a 10% ROE so an adverse decision would not negatively impact all of its operations, but it would still cause the company’s FY 2016 estimated earnings to be revised lower. Valuation Analysts have revised their estimates for the company’s earnings FY 2016 earnings lower over the last 90 days in response to slowing economic growth in Texas and the possible delay in the implementation of new rates for the year. While the consensus estimated EPS for FY 2015 has remained flat at $1.56, the consensus for FY 2016 has fallen from $1.85 to $1.65. Both results would reflect a positive trend on an adjusted basis that has been in place since at least FY 2010. That said, based on the company’s share price at the time of writing of $24.74, this earnings growth has not outpaced the company’s share price. The current share price results in a trailing P/E ratio of 16.3x, which is roughly in the middle of the company’s 3-year range (see figure). The forward P/E ratios for FY 2015 and FY 2016 of 15.9x and 15.0x, respectively, are near the bottom of their respective 3-year ranges, although ratios of 13.5x and 13.0x for FY 2015 and FY 2016 would represent true bottoms (as well as a share price of $21.40, or a discount of 14% to the current share price). PNM PE Ratio (NYSE: TTM ) data by YCharts Conclusion PNM Resources has seen its share price fall substantially since the beginning of the year in response to slowing economic growth in its service areas, regulatory uncertainty at both the state and federal levels, and broad bearish sentiment with regard to dividend stocks in light of anticipated interest rate increases by the Federal Reserve. While the company appears to be undervalued on the basis of earnings estimates for FY 2015 and FY 2016, I believe that potential investors in the firm should require an additional discount to the current share price to compensate for the risks of a slowing Texas economy resulting from low energy prices and the prospect of adverse regulatory actions later in the year. I recommend that potential investors wait to initiate a long position until the company’s shares set a new 3-year low on the basis of forward valuations, or a share price of $21.40 based on current EPS estimates. While the company’s reliable earnings and dividend growth and current 3.1% dividend yield are attractive, the prospect of regulatory and economic headwinds should give potential investors pause. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.