Tag Archives: utility

Strong Fundamentals The Name Of The Game For Southern Company

Summary SO’s fundamentals strongly backed by its hefty capital investment plan. The company is utilizing available growth opportunities in the U.S. utility sector to keep earnings growing. SO is actively expanding its renewable energy generation portfolio. The stock is a good investment prospect for long-term income-seeking investors. Utility companies have a defensive business model because of consistent demand and regulated business exposure, which make revenues and cash flows highly certain. In the recent past, utility companies are incurring capital expenditures, which have been weighing on their earnings and cash flows. Utility companies are making capital expenditures to strengthen their power generation infrastructure to keep up with the gradually increasing electricity demand and keeping up with the changing environmental regulation. According to the EIA, electricity demand in the U.S. residential area will increase by 2.1% in the second half of 2015. The report also confirms 1.3% and 1.2% rises in commercial and industrial sales of U.S. utility companies in 2016. The bright outlook of the U.S. utility industry makes me bullish about Southern Company (NYSE: SO ), which is one of the largest utility companies in the U.S. The company serves both regulated and competitive markets across the U.S. SO is making its way in the U.S. utility industry by regularly investing heavily in expansion and the development of its renewable regulated asset base. Also, the stock maintains its attractiveness for income-hunting investors, as SO offers a yield of 4.8%. However, on the valuation front, anticipated production cost overruns at Kemper is making it trade at a discount to peers, which I think provides a good entry point for long-term investors. The company has been reporting healthy financial numbers, due to the strong backing of its large regulated asset base. The company registered an EPS of $1.17 in 3Q2015, an increase of $0.25 per share from EPS of the previous year’s same quarter. And for the nine months ending September 30th, the company’s EPS was $2.30, as compared to an EPS of $1.88 reported in the same period a year ago. The earnings growth momentum of SO is expected to remain strong in 4Q’15, which as per management’s estimates, will yield it a year-end EPS of $2.88 per share, at the high end of the previously given annual EPS guidance range of $2.76 to $2.88. I consider the company’s capital investment plan for the creation of a strong renewable energy generation base as a key driver of its future earnings growth. Recently, SO has announced that it will invest $2.3 billion this year, higher than its previous expectations of $1.4 billion. Although there are additional projects under consideration for 2016, its management still expects to spend around $1.3 billion during the year. Year to date in 2015, the company has announced around 12 new renewable energy-related projects, which will add 1,000MW capacity towards its existing renewable portfolio’s current capacity of 1,600MW. SO has been actively acquiring solar facilities to grow its portfolio of renewable energy generation. The company continued to develop itself as a solar success story by acquiring the 300MW Solar Gen2 and the 300MW Desert Stateline projects from First Solar (NASDAQ: FSLR ). The acquisition being in line with SO’s business strategy of expanding wholesale business in targeted markets through the acquisition and construction of new units, will bode well for SO’s earnings growth in the long run. Moreover, the company is right on track to become the second largest gas utility in the U.S. by merging with AGL Resources (NYSE: GAS ). The merger is waiting for regulatory approval, expected in the second half of 2016, after seeking a nod from AGL’s shareholders. Upside of this merger rests in strengthening SO’s status as the regional powerhouse in southern U.S. Moreover, given the size of GAS, I believe the probable GAS-SO merger will boost overall earnings growth of the company by approximately 4% to 5%. More importantly, SO’s future earnings growth will be driven by the settlement of its Vogtle nuclear power plant. By keeping the nuclear power plants schedule on time, in-service dates of two nuclear power plants are expected to be 2019 and 2020. Actually, customer rate impact for Vogtle unit 3 and unit 4 is expected to remain in the previously predicted range of 6% to 8% , which will affect the company’s future earnings and free cash flow growth positively. Speaking of its clean coal power plant ‘Kemper’, which has been repeatedly delayed in the past few quarters, has resulted in stock valuation contraction. The stock is trading at a forward P/E of 15.34x , in contrast to the utility industry’s forward P/E of 18.85x . The management expects that the project will be operational from the first half of 2016, but in early October, the Mississippi Public Utilities staff analyzed the Kemper project and said that there is hardly a 30% chance that the project will be completed by December 2016. Given the fact that the company’s management has estimated a $25 to $30 million incremental cost, if the project is delayed in the second half of 2016, I believe the Kemper project will remain an overhang on the stock price in the near term. However, once the project is completed, it will augur well for the stock valuation. Furthermore, SO has an attractive capital repayment plan, strongly backed by its cash flows. In the current low interest environment, its current dividend yield of 4.80% , with its strong free cash flow growth potentials, is well headed to ensuring a safe and sustainable future of income investors, and casts an impressive outlook of the stock. Summation The company has strong business fundamentals, which are strongly backed by its hefty capital investment plan. In its attempts to keep its earnings growing, SO is utilizing the available growth opportunities in the U.S. utility sector. And for this, the company is actively expanding its renewable energy generation portfolio, which being regulated, offers huge earnings growth potentials. Owing to the strong growth potentials of SO’s ongoing renewable energy generation projects, I expect to see uninterrupted growth on its earnings and cash flows in the long term, which I think will help its shareholders to be satisfied by consistently increasing dividends. Therefore, I think the stock is a good investment prospect for long-term income-seeking investors.

The Vanguard Utilities ETF Is On My Holiday Shopping List

Summary The expense ratio and dividend yield are both great. The dividend yield could be further enhanced by changing the weighting structure to emphasize utility companies with stronger yields. The Federal Reserve meeting on December 16th may include a rate increase that could create some nice sale opportunities on utilities. As we prepare for the holidays, I’m getting my shopping list ready. One of the additions to my list is the Vanguard Utilities ETF (NYSEARCA: VPU ). I’ll take investors through my reasoning for putting this on the list as a potential acquisition for the middle of December or later. Expense Ratio The ETF is posting .12% for an expense ratio. What else is there to say? That is a solid expense ratio and makes this fund one of the cheapest options for exposure here. Largest Holdings The diversification within the ETF is pretty weak. For a very long term holder it might make sense to replicate the ETF by just buying the underlying securities and taking higher trading costs to eliminate the expense ratio. However, an expense ratio of only .12% would be difficult to beat without a fairly long time horizon or a large volume of commission free trades in the account. (click to enlarge) The major holdings here are the same ones I would expect to see. Duke Energy Corporation (NYSE: DUK ) is a fairly huge utility company and frequently at the top of the list for utility ETFs. All around this appears to be a reasonable portfolio for an investor that wants to get more utility companies into their portfolio without having to buy the companies individually. Top Dividend Yields The following chart demonstrates the top 10 utilities for dividend yield that have increased their dividend for at least the last 5 consecutive years: Symbol Company Name Yield Years CNP CenterPoint Energy 5.34% 10 SO Southern Company 4.81% 15 DUK Duke Energy Corp. 4.62% 11 PPL PPL Corp. 4.39% 14 STR Questar Corp. 4.07% 36 ALE Allete Inc. 4.02% 5 DGAS Delta Natural Gas 4.01% 11 ED Consolidated Edison 3.95% 41 AEP American Electric Power Co. 3.95% 6 NWN Northwest Natural Gas 3.91% 60 There is quite a bit of cross over between the list as DUK, PPL, AEP are on the top 10 holdings and the 10 utilities for high yields. Because VPU is using a market capitalization weighting scheme, their top holdings are dominated by the largest capitalization utility companies. Using a market capitalization weighting scheme is great for keeping expenses low and maintaining a passive style, but the strategy does nothing to boost the dividend yield of the portfolio. If the price of shares in a utility is increasing but their dividend is not, that utility will see their ranking within the portfolio increase. While I’d prefer to see a focus on utility companies that offer a strong combination of high yields and expected growth in their dividends over the next several years, I’m still consider VPU as a potential holding due to the very low expense ratio and desire to maintain diversification in my portfolio. Looking For Utilities With the Federal Reserve poised to raise rates in December, it seems like a great time to be fishing for good prices on utility companies with an eye to keep buying as long as rates are going up and prices are going down. Utilities tend to have a significant correlation with bonds and an increase in rates will generally send share prices lower. To put that a different way, an increase in bond yields will drive an increase in utility yields. If the price of the utility is falling simply because bond yields are moving higher and the utility yield needs to move in a similar fashion, that is a fine buying reason for me. VPU or Individual Utilities If my portfolio was large enough to plan on buying 10 individual utilities with material allocations to each, I’d be treating individual utilities as being a superior plan to simply buying into VPU. However, going into December I am also looking to beef up my position in equity REITs with the Schwab U.S. REIT ETF (NYSEARCA: SCHH ), and my international positions with the Schwab International Small-Cap Equity ETF (NYSEARCA: SCHC ) or the Schwab International Equity ETF (NYSEARCA: SCHF ). Since I won’t have a great deal of cash left over, I would be more likely to look at taking VPU rather than buying up the individual securities. Conclusion Utility companies can act as a form of income investment because of their strong dividend yields. Unlike buying into a bond portfolio investors can expect that the level of dividends will be increasing over time which makes up for the portfolio having more risk than a simple bond portfolio. I’ve added VPU to my list of ETFs to keep an eye going through December and into early 2016 as a possible candidate. I won’t make those moves in the next few days, but I’ll be looking to see if shares fall hard after the Federal Reserve meeting on December 16th.

Exelon Corp. Is A Buy

Summary EXC has a low beta which will help during potential market downturns. EXC underfunded pension liability offers a “negative earnings duration” which will benefit from rising rate environment. Forward dividend yield of 4.48% is supported by large dividend coverage ratio. Common shares are selling at a discount compared to historical valuations and peer group. Exelon Corp. (NYSE: EXC ) is a utility services holding company engaged in the energy generation and delivery business through its segments, Generation ComEd, PECO and BGE. According to the company’s website : Exelon’s family of companies represents every stage of the energy value chain. Exelon Generation is one of the largest competitive United States power generators, with approximately 32,000 megawatts of owned capacity comprising one of the nation’s cleanest, lowest-cost power generation fleets. Constellation provides energy products and services to more than 2 million residential, public sector and business customers, including more than two-thirds of the Fortune 100. And Exelon’s three utilities deliver electricity and natural gas to more than 7.8 million customers in central Maryland (BGE), northern Illinois (ComEd) and southeastern Pennsylvania (PECO).” Every day, we hear news about an impending stock market decline and an increase in interest rates. It was under this pretense that I went searching for companies that provide protection in both a rising interest rate environment and low beta stocks which could spare my portfolio in the event of a downturn. Low Beta The beta of a stock represents the systematic (market) risk of a company. When the beta is positive, the stock prices tend to move in the same direction as the market, and the magnitude of the Beta tells by how much. A stock beta greater than 1 implies that when the market goes up by 1%, we expect the stock to go up by more than 1% – the opposite is true if the market goes down by 1%. Utility companies are considered “Defensive” stocks because they typically have steady cash flows, attractive dividend yields and lower-than-average betas. Exelon is considered a “Diversified Utilities” company and has a lower-than-average beta of .24, compared to an average beta of .48 for all the “Diversified Utility” companies in the Russell 3000. All else being equal, we would expect to outperform its peer group in the event of a market downturn. Negative Earnings Duration What makes this sector especially enticing is that most of the firms have underfunded pensions, which represents a liability on the balance sheet. While that sounds ominous, it is quite common for older companies with pensions given the large amount of baby-boomers retiring today. In order to calculate the magnitude of the underfunded pension, you need to project out the future pension payments and discount them back at a specified rate of return, typically tied to the current interest rates. The difference in the pension liabilities is added or subtracted from earnings, depending on whether the liability is becoming smaller or larger. I like to call this “negative earnings duration” because the liability becomes smaller when you increase the discount rate (denominator). Duration measures the fall in price of a security given a 1% (parallel) rise in interest rates. In fixed income terms, we can say EXC has a negative earnings duration because earnings rise in a rising rate due the reduction in pension liability. Increasing interest rates reduce pension liabilities and increase earnings, all else equal. A quick glance at the magnitude of underfunded pensions in this sector makes EXC standout as an EPS beneficiary in a rising rate environment, given the size of its pension liability. On the Q3 conference call, Exelon management mentioned that every .25% rise in interest rates will lead to a .02 EPS increase. (click to enlarge) EXC selling at a discount compared to historical valuations and peer group Currently, EXC is selling below its 3 and 5 year price/earnings multiples, which could imply future mean reversion. Diversified utility companies typically have predictable cash flows and earnings due to the nature of the business and their hedging strategies. The charts below highlight the current PE multiple compared to its 3- and 5-year median as well as EXC quarterly earnings compared to analyst estimates. As expected, the actual earnings tend to oscillate around the estimates. (click to enlarge) (click to enlarge) Compared to its peer group, Exelon is selling at a discount by a nice margin based on PE multiples which implied that it is cheaper to own per share of earnings compared to its peer group: (click to enlarge) Dividend Coverage and Valuation Investors look to the utilities sector for dividends and EXC has not disappointed. The company has paid dividends consistently over the last 10 years and sports a healthy dividend coverage ratio. Dividend Cover is calculated by EPS/Common Dividends. For companies such as Exelon that are known to consistently pay dividends, taking a look at the dividend coverage ratio can be an effective way to see if dividend payments are being harder to make over time. Currently, dividend coverage is 1.816, which is healthy from historical perspective and makes the current dividend yield of 4.49% all the more attractive: (click to enlarge) When valuing EXC, we can look at the historical price earnings and price sales ratios for Exelon and its peer group over the last 20 years. From there, we can use the 2015 estimates for earnings and sales to derive a price for each and average the two together: Historical PE Multiple for EXC and Peer Group Average Median Blend 2015 EXC EPS estimate Price 1995-Present 22.9 16.2 19.55 2.5 48.875 Historical PS Multiple for EXC and Peer Group Average Median Blend 2015 EXC sales per share Price 1995-Present 1.5 1.23 1.365 28.11 38.37015 Source: Ycharts Blended price based on PS and PE 43.6258 Based on historical analysis, an intrinsic value of $43.62 represents a 58% upside from the current price ~$27.5 per share. Given EXC’s dividend coverage, low beta, (-) earnings duration and discount valuation, I believe it is a buy at these levels.