Tag Archives: utility

Consider Midwest Utility ITC Holdings For Your DGI Portfolio

Summary Following my analysis of Wisconsin Energy, Southern Company and Avista, I decided to look at another possible growth prospect in the utilities sector. ITC offer superb growth opportunities together with great fundamentals and fair valuation. However, there are still several risk factors that must be taken into consideration, especially when we know it is a utility company. If you follow my last two articles, you will see that lately I am writing and debating with the readers about utility companies. I also wrote two articles about utilities back in March. The debate is whether one should look for a classic utility with high yield and low growth such as Southern Company (NYSE: SO ) or medium yield and medium growth like Wisconsin Energy (NYSE: WEC ). I must also note that I invest in Avista (NYSE: AVA ) as well, which also has medium yield and growth. I mentioned two out of the three types of dividend growth stocks. The third one is low yield and high growth. ITC Holdings (NYSE: ITC ) is a great example of such a company. I am going to analyze this company in this article, as I try to look for new investment opportunities. I found this stock while doing one of my routine screening, and I found out that it isn’t well known among dividend growth investors. ITC Holdings is a holding company. Through its regulated operating subsidiaries, International Transmission Company, Michigan Electric Transmission Company, ITC Midwest LLC and ITC Great Plains. It is engaged in the transmission of electricity in the U.S. It operates high-voltage systems in Michigan Lower Peninsula and portions of Iowa, Minnesota, Illinois, Missouri and Kansas that transmit electricity from generating stations to local distribution facilities connected to its systems. Fundamentals The fundamentals shown by ITC are really remarkable. They are remarkable for any company, and especially for a utility company. The revenue rose steadily over the past decade. Ten years passed since the initial IPO of the company, and in these ten years the revenue grew from $200 million in 2005 to $1020 million in 2014. This is CAGR of 17.69%. This rate will not be sustained, but the revenue will keep growing in the next years to come at high single digits according to the management. ITC Revenue (Annual) data by YCharts EPS also grew in a very impressive manner, and it is going to grow quickly in the next years to come. Issuance of new shares slowed the EPS growth, but as you will see, it had very little effect. The EPS grew from $0.353 in 2005 to $1.54 in 2014. This is CAGR of 15.87%. This is again an amazing number especially for a utility. The company is forecasted to show EPS of over $2 in 2015. The company reiterates its five year plan, and is going to show double digits EPS growth until 2018. ITC EPS Diluted (Annual) data by YCharts The dividend also grew quickly over that decade. It grew at a slower pace than the EPS, so the payout ratio actually declined to around 36%. In addition, the company told investors in November that it might expand the payout up to 40% in the future. The dividend grew from $0.175 in 2005 to $0.61 in 2014. This is CAGR of 13.3% which is great. In 2015 the dividend was raised by additional 15%, and the management is willing to raise the annual payment by 10%-15% annually. The drawback is that the current yield is very low for a utility company at just 2.2%. ITC Dividend data by YCharts Over the past decade the amount of shares outstanding increased by around 50%. This is typical for companies that are growing, issuing equity is a common way to raise capital. However, in the last two years, 2014 and 2015, the board authorized a buyback plan of $250 million. The board is positive about the strength of the balance sheet and the cash from operations, and I believe it will issue another similar plan in 2016. $250 million is around 5% of the shares outstanding, pretty impressive. Valuation ITC is really fairly valued. The forward P/E is around 16. When taking into consideration the double digits growth rate, some might say that the valuation is low. The high growth rate is lowering the P/E for 2016 and 2017 significantly. If I have to determine, I find it valued fairly to slightly undervalued. ITC PE Ratio (NYSE: TTM ) data by YCharts The reasons for the lower valuation are the fact that ITC is a less known company with no buzz at all, and the fact that the dividend yield is extremely low for a utility company. If the company can achieve its dividend growth goals, it will be a great opportunity for long term investors. Opportunities ITC enjoys a high rate of revenue, EPS and dividend growth. This growth is achieved while the company is practically a monopoly in several states, as it possesses a very wide moat due to its massive infrastructure. If the company can grow that quickly while being a supervised monopoly, it has a pretty bright future. ITC will also enjoy the transformation on the American energy market. As power plants using coal are closed, and plants using naturals gas and renewable energy are opened, they will all need to transmit the electricity from the plants to their customers. The massive infrastructure owned by ITC will be ready to join forces with the power plants. In my previous article about Southern Company and Wisconsin Energy, I was told by several readers, that SO has an advantage over WEC, and it is the fact that it operates in the growing south and not in the Rust Belt. I am not sure that this is an advantage for the long term, as the economy is cyclical, but ITC for sure has nothing to worry about it. The company is well diversified, and it operates and in the Rust Belt as well as in the south. Geographical diversification is always a plus for a utility company which is usually locked in a certain area. Another advantage is the regulation. While the typical utility company is regulated by the states and the federal government, and therefore in a position where it can suffer from multiple state jurisdiction, ITC is solely regulated by the federal government, because it is an electric transmission company. In addition, the allowed return on equity is higher, which allows the company to charge more money for its service. According to S&P, the allowed ROE by the federal government is between 12.16%- 13.88%. Risks The first risk is competition. The competition can come from two places, other transmission companies especially from the west, and electric companies that can build their own infrastructure. The advantage of ITC is the fact that infrastructure requires a lot of capital. This is the wide moat that the company has, and the reason for this risk to be less relevant at current prices. The federal regulator received in 2013, a complaint asking for the reduction of the allowed ROE. A similar case in New England back in 2011 resulted in reduction of the allowed ROE two years later. This might harm the profitability. However, the request wasn’t fully granted, and I believe that the same will happen here as well. The low dividend is another downside. Yes, it can and should grow in the near future. The company believes that it can sustain substantial growth for the long run here. However, the profits depend on the regulators, and a change in the regulation might slow down the dividend growth, and we will have a utility stock that yields less than 2.5%, not something to brag about. The debt load is high, and is getting even higher. With the interest rates raising, it will be even more expensive. The company is using at the moment debt to finance its operation. The expects annual cash from operations to be around $650 million, while the annual capital investment is $800 million. Now, add the dividend and the buyback, and this small company must have access to credit at all time. The management is aware of that, and they know that their goal is to maintain the current credit rating- A. Conclusion Well, I can’t see myself buy ITC now, I prefer WEC and AVA over it. The growth is important and unique for a utility, but it will take years for it to reach a “utility yield”. It will need 5 years of superb growth to reach the yield of WEC, and 8 years of superb growth to reach the yield of SO. My preferred utility companies are the medium growth and medium yield like WEC and AVA. Therefore, I prefer these two over both SO and ITC. If you have several utilities and a very long investment horizon, you should consider adding ITC to your dividend growth portfolio. If you are a value investor, you might be buying it as well, as the growth prospects are here and valuation is fair. You can initiate a small position and enjoy the growth, it is an odd utility by yield and payout ratios as well as by growth, but it is also a great company, that isn’t necessarily right for my portfolio.

Future Growth Opportunities For Duke Energy After Piedmont Acquisition

Duke Energy expands its reach from the electric utility industry into the natural gas business. Increases Duke Energy’s stake in very profitable Atlantic Coast Pipeline while tripling gas customers. Expect to see increased EPS for Duke Energy. By Matt De Jesus I have a strong buy recommendation for Duke Energy (NYSE: DUK ) after its acquisition of Piedmont Natural Gas. Duke Energy acquired Piedmont for $4.9 billion, and will also assume around $1.8 billion of its debt, representing an enterprise value of close to $6.7 billion for Piedmont. Duke Energy paid a 40% control premium on the acquisition, paying out Piedmont shareholders $60 in cash for each share outstanding. Reasons they paid this high premium are related to the possible synergies related to the deal. This acquisition is a good deal for Duke Energy, as they try to grow in the utilities industry and possibly expand nation wide. Duke Energy is the largest electric power holding company is the country, and is headquartered in Charlotte, N.C. Before acquiring Piedmont, Duke Energy was known for producing electricity, and not a big name in the gas industry. However, with the electricity industry showing signs of stagnant growth, Duke Energy wanted a piece of Piedmont Natural Gas for a couple of reasons. First, the natural gas industry is growing, whereas the electricity industry is not. Utilities are going through a period right now where natural growth is slow, so companies, like Duke Energy, must grow through acquisitions. The natural gas market, according to Wall Street analysts, is bullish right now, so everyone is trying to get into the gas business, adding significance to Piedmont’s acquisition. They will receive all of Piedmont’s existing customers, thus tripling its number of natural gas customers from 500,000 to 1.5 million. Also, with Duke’s established brand and stake across the southeast, I expect these numbers to grow further. The second reason Duke Energy acquired Piedmont was because of the Atlantic Coast Pipeline. Now owning Piedmont, Duke Energy increases its stake in the $5 billion Atlantic Coast Pipeline to 50%. More importantly, because of the state regulations on Piedmont’s fuel delivery incorporated with the pipeline, the acquisition provides Duke Energy with a steady and predictable profit, which is very important in the utility industry. Much of a utility companies growth is based on a rate base, which is the value of property on which a public utility is permitted to earn a specified rate of return. So, utility companies make money off returns on investments in property for the company. This is why the regulated returns on the Atlantic Coast Pipeline are so important, as they are consistent and profitable. Third, the move is in line with the company’s possible plans to grow throughout the U.S. and not just stay in the Carolina, southeast area. By establishing itself in the gas industry, Duke is scaling itself for the long-term next step in its growth, which may be to take the company nationwide. This move would not be any time in the near future, as Duke must first establish itself in the gas industry. Some may question Duke Energy’s paying such a high control premium to buy out Piedmont, but in the long run, this is a great deal for the company. The deal enhances Duke’s forecast EPS rate of 4% to 6%. To give some perspective, Piedmont’s rate base and EBITDA have been rising annually at about 9%. Duke’s stock price is currently at $67.32, and has been down recently because of the debt involved with the deal and slowed growth in the electric utility industry. The 52-week low on the stock is $67.07, with the high being $89.97. This deal, in the end, will be good for Duke, and it’s investors because it will enhance EPS. The stake in the Atlantic Coast Pipeline is very integral to this, and will provide regulated profit for the company even when the market for electricity is down. Also, the market for natural gas is bullish, and with a big company like Duke Energy providing natural gas, investors will reap the benefits of the profits Duke will make from Piedmont. We’ll see Duke Energy grow in these next months/year, but it will take some time before we see the major benefits from this deal.

Why Are Utility Black Hills Investors Seeing Red?

Black Hills recently priced a secondary offering at a full 30% off its peak price in 2014. The acquisition of SourceGas doubles its community count in states they currently service. While Moody’s and Fitch placed Black Hills on “Negative Watch”, they are generally supportive of the company’s business profile. Black Hills Corp (NYSE: BKH ) is a small cap diversified utility whose stocks price has collapsed from $60 in June 2014 to $40 currently, with share prices down 10% on Nov 17. The answer lies in two circumstances: its business profile and the issuance of dilutive equity to fund an acquisition. The first situation is more long-term and the second more short-term. Originally founded 132 years ago in Deadwood, ND (interesting name for an investment headquarters), BKH has a long history of dividend increases, stretching back to 1970. Black Hills is a utility with regulated natural gas and electricity assets and non-regulated assets, with the non-regulated assets generating the negative issues. BKH mines coal, generates electricity with coal, and explores for oil and natural gas. These business segments are currently out of favor with most investors, and are creating financial stress. Black Hills services 680,000 customers in Colorado, Iowa, Kansas and Nebraska along with 110,000 customers in South Dakota, Wyoming and Montana. 205,000 are electric customers and 585,000 are natural gas customers. Below is a graphic of its service territory. (click to enlarge) The annual dividend is currently $1.62, for a yield of 4.0%. The company has a 45-year string of dividend increases, driven in part by strong industrial load growth in electricity. Over the previous 5 years, Black Hill’s growth has been in its regulated utility business. In 2009, regulated utility business generated $126.2 million in operating income vs. $19.9 million for non-regulated. Last year, regulated businesses generated $222.4 million vs. $39.3 million for non-regulated. At no time over the previous 5 years has the non-regulated segment generate over $45 million in operating income while operating EPS over the same time frame increased from $1.38 to $2.93. Management has forecast operating EPS of $2.90 to $3.10 for this year, midpoint $3.00, and $3.15 to $3.35 for 2016, midpoint $3.25. According to S&P Credit, the states serviced have the following regulatory environment (based on three groups of regulatory friendliness – Strong, Strong/Adequate, and Adequate): Colorado and Iowa – Strong; Kansas, Nebraska, South Dakota, Wyoming, Montana – Strong/Adequate. Pre-2014, S&P Credit offered five categories of regulatory friendliness and it seems Colorado, Wyoming and Montana improved their relative positioning. In addition, Black Hills geographic service territory includes some of the higher economic growth rates. Below is a map from the Bureau of Economic Advisors of economic growth by State for 2014. As shown, Colorado and Wyoming exceeded the national average growth rate of 2.2% while the balance of the states served fell short. In general, the Rocky Mountain States saw their economic growth rate expand from 1.4% in 2011 to 3.9% in 2014 while the Plains saw their rate of growth slashed from 2.1% to 1.3%. This underlying economic growth helps to lift energy demand. (click to enlarge) Similar to the entire oil and gas exploration and production industry, BKH has experienced large non-cash write-offs for redetermination of its natural gas reserve values. The YTD charges amount to $2.53 a share, or $110 million, reducing Trailing Twelve Months reported earnings to $0.37 vs. TTM operating earnings of $3.07. In tune with their peers, BKH has slashed its capital expenditure budget for oil and gas exploration from $242 million to a measly $27 million. From an overall observation, BKH’s future lies with its regulated business, as the non-regulated business will continuing to provide a drag on investor interest. Presently, Black Hills can provide about 50% of its natural gas delivery needs from internal production, and with commodity pass-through provisions, allows BKH to be more self-sufficient than other small natural gas utilities. While not a large attribute in these times of low gas prices, if prices were to rise over time, this could add another potential profit layer. In early summer, Black Hills announced it was buying a neighboring natural gas utility from private sources. In July, BKH announced it was buying SourceGas from an investment fund owned by Alinda Capital Partners and GE Energy Financial Services for $1.89 billion, including assumption of $720 million in debt. The expansion will add 425,000 customers and solidify its position in its existing service states as the number of community served doubles to 800. In addition to the current seven states, BKH will add Arkansas customers. However, to fund the acquisition, this week management priced a 5.5 million share secondary offering at $40.50 a share, for a dilution of about 12%, based on 44.5 million shares outstanding before and 50 million after. The company will also offer equity units comprising of an interest in a 2028 subordinated debt and a collar contract to buy additional common shares between $40 and $47. When exercised, the equity units will further dilute share count by 10% and the equity unit is expected to yield 7.5%. Net proceeds from these two are expected to total $465 to $535 million on their close at the end of Nov. The original acquisition funding estimates called for $575 to $675 million in new equity. This still leaves new debt issuance of between $590 and $660 million, and is higher than the original estimate of $450 to $550 million. In connection with the acquisition, Moody’s and Fitch credit rating agencies lowered BKH’s outlook to “negative”. The added concern mainly focuses on higher debt levels BKH will take on. Moody’s comments : However, the decline in financial metrics is slightly offset by the anticipated improvement in the company’s business risk profile. The transaction brings increased scale and diversity as well as additional opportunity to grow rate base in the constructive regulatory environments that SourceGas operates in. It improves Black Hill’s overall risk profile as it adds low-risk LDC utility operations and reduces the proportional size of its higher risk E&P operations. The rating affirmations and stable outlooks on Black Hills Power and SourceGas reflect the companies’ stable utility operations with visible growth opportunities. Because Black Hills already operates in three of SourceGas’ four states, we expect Black Hills to improve efficiency by combining utility operations and to be better positioned in these states through the increased scale. Arkansas is the only state where Black Hills currently does not have any operations. In recent years, SourceGas has experienced improvements in its regulatory environment in Arkansas, including a reasonable outcome in its rate case in 2014. Fitch’s comments : BKH operates regulated electric and natural gas utilities in seven states, all of which allow for pass-through of commodity and/or purchased power costs and many feature other riders or recovery mechanisms that enhance timely recovery of expenses and invested capital. Transmission investments are regulated by the Federal Energy Regulatory Commission (FERC) or state regulatory commissions with most capital expenditures eligible for rider recovery. The diversity by regulated jurisdiction further enhances the predictability of cash flows and minimizes the effects of exogenous factors. Non-regulated investments consist of a legacy upstream energy exploration and development business. Fitch considers BKH’s coal and competitive generation businesses, which are largely contracted to BKH’s utilities, as possessing relatively low risk. BKH’s utilities, coal, and merchant generation businesses have a large degree of operational and financial integration, with jointly owned or contracted generation and common call centers. BKH has interests in the Mancos shale play and is committing relatively large capital investments in order to further assess and prove its potential reserves in the area. BKH’s proposal to place a portion of its natural gas assets into a nonregulated exploration and production subsidiary, which would supply its utilities with up to 50% of annual gas consumption through long-term contracts, if successful would reduce the inherent risks and volatility of the non-regulated oil and gas business segment and would be viewed positively by Fitch. BKH has traditionally managed this business in a conservative manner and uses swaps and other instruments up to two years in duration to hedge pricing risk. Black Hills has earned a disappointing S&P Equity Quality Below Average Rating of “B”. Fastgraph outlines the current valuation for BKH in the chart below, along with a historic review of return on invested capital ROIC. ROIC between 2006 and 2011 were at sector average of 4% to 5%., but has improved since 2011. (click to enlarge) Source: fastgraph.com (click to enlarge) Source: fastgraph.com Since 2014, investors have punished BKH with a substantial stock price haircut, but the barber may not yet be done. By all accounts, the acquisition of SourceGas will reduce the company’s risk profile by increasing its regulated footprint in states where they have a good PUC relationships. Black Hills would be more enticing with a further dip in price to generate a higher yield, but nibbling here could offer interesting opportunities as a small-cap portfolio diversifier serving the Rocky Mountain and Plains geographic area. Author’s Note: Please review disclosure in Author’s profile.