Tag Archives: utility

Will The Supreme Court Alter Your Utility Investment Strategy?

An obscure legal case could impact several electric utilities in states where wholesale power pricing is controlled by Regional Transmission Organizations, such as PJM Interconnect. Demand Response technology is at the heart of the issue. Is the Federal Government overreaching into the territory of state’s rights? The US Supreme Court SCOTUS could be intruding into your electric utility investment strategy. In an obscure case entitled Federal Energy Regulatory Commission v. Electric Power Supply Association (FERC v EPSA), SCOTUS will settle a long standing dispute between the FERC and power producers. At the heart of the conflict is the implementation and impact of Residential Demand Response (DR) technology. Pricing for electricity and hence the profitability of several electric utilities hang in the balance. Demand Response is the ability of specific electric appliances to turn off during times of high cost power, also known as “smart” appliances. Stated more clearly: Conservation implies whether to consume energy; Efficiency deals with how to consume energy; Demand Response concerns when to consume energy. Oilprice.com offers an interesting recap of the issue: Demand-responders argue that a megawatt saved is financially equal to a megawatt produced by a power generator. The power generators who comprise EPSA recognize that DR will hurt them, reducing both power prices and their profitability, to the benefit of consumers. Adding DR to a power market is the competitive equivalent of adding more generators. Either way, added competition lowers prices. The issue before the court is whether the FERC can compel regional power producers to pay consumers who reduce their use of power at peak times and if so, at what price. An interesting analogy could be the government program to pay farmers for not planting crops. In this case, power companies would pay consumers not to use electricity from the grid during times of peak demand. Daily peak demand varies based on location. For example, in Arizona where air conditioning is a large portion of demand, Arizona Public Service bills customers the following schedule: The plans billed on an off-peak and on-peak basis, with a super peak period in the summer billing months of June – August. Off-peak hours are weekdays from 7 pm to noon and all day Saturday and Sunday, as well as 6 major holidays; on-peak hours noon – 7 pm weekdays are billed at a higher rate; super-peak hours (3-6 pm weekdays during June – August) are billed at the most expensive cost per kWh. Save money when you use more energy on weekends and weekday mornings before noon or evenings after 7 pm. From their rate card , APS off-peak hours are billed at $0.05517 per kWh while on-peak rates vary from $0.19847 in April and $0.24477 in May, with super-peak costing $0.46517 in June. FERC Order 745 implements a program where power producers pay retail customers the going purchase rate for power not consumed, if the demand response is economical and helps balance the energy load on the Grid. The power producers contend this overcompensates as the variable cost to generate electricity is less than the retail price. In addition, the power producers claim the Order is an over-reach by the FERC as retail power rates are set by individual state utility commission boards, some of which are elected by the general population. In May 2014, the DC Federal District Court of Appeals ruled in favor of the power producers, resulting in FERC’s appeal to the SCOTUS. The Circuit threw out FERC Order 745’s compensation calculation and found that FERC has no jurisdiction over Demand Response, placing jurisdiction back on the states. The amount of money Demand Response could represent are not insignificant. The table below is an estimate from GTM Research for the forecast of the U.S. demand response market – with and without FERC Order 745. Source In a review of Con Ed (NYSE: ED ), I discussed the implementation of the “Clean Virtual Power Plant” where ED is developing a network of solar panels and electricity storage to supply the Grid with power when the solar panels are ineffective. If this becomes a viable business model in connection with higher Demand Response expansion and the FERC Order 745 of paying the highest prices for DR, wholesale power prices controlled by Regional Transmission Organizations, such as PJM in the Mid-Atlantic and eastern Midwest, could alter profitability for power producers. Which electric utilities could affected? GTM Research offers the following map of the highest kW replacement from DR, by Regional Transmission Organization: (click to enlarge) As shown, 68% of the Demand Response reduction in MW demand comes from areas under the jurisdiction of PJM and MISO, and includes a large swath of 31 states. Utilities with power generation in these states affected include Exelon (NYSE: EXC ), FirstEnergy (NYSE: FE ), American Electric Power (NYSE: AEP ), Dominion Resources (NYSE: D ), and Duke Energy (NYSE: DUK ). More information can be found in an interesting article published by utilitydive.com. Investors should keep an eye out for the ruling by SCOTUS concerning FERC Order 745. The impact could affect the profitability of many utilities selling wholesale power in various RTO jurisdictions. Author’s Note: Please review disclosure in Author’s profile.

Algonquin Power: U.S. Dollar Dividend, Canadian Dollar Share Price, And Huge Insider Ownership

Algonquin Power is getting lots of love from Canadian stock analysts. It has a unique structure of paying its dividend in US Dollars, removing foreign exchange risk for income investors. Insiders own 19% of the company. Algonquin Power and Utilities ( OTCPK:AQUNF ) (AQN.TO) is a Canadian-based electric, natural gas, and water utility serving 488,000 customers. US investors are offered an interesting combination of above-average dividend growth paid in US Dollars while gaining exposure to the benefits of a falling US Dollar with a company well liked by Canadian research analysts. Management expects 15% growth in assets, approximately 15% growth in adjusted EBITDA and greater than 10% growth in adjusted EPS. In Canada, the majority of assets are in renewable power generation while its US footprint is strong to utility distribution with 31 electric, gas, and water businesses. Algonquin Power’s cross-border structure provides an interesting twist for US investors: Income is paid in US Dollars and share prices trade in Canadian Dollars. While dividend growth investors may turn their heads at a huge dividend cut in 2009, an understanding of the company’s structure should overcome this stigma. Water will be a bigger part of Algonquin Power. AQUNF is working on acquiring the water utility assets of private equity firm Carlisle Infrastructure Group LLC. After the acquisition of California and Montana based Park Water is complete, Liberty Utilities will be the 6th largest US water utility by customer count. However, two municipalities, Missoula, MT and Apple Valley, CA are trying to purchase their respective water districts and have been aggressive in filing court documents seeking to force these businesses back into the public domain. Until these issues are resolved, the acquisition cannot proceed. The company recently expanded its Distribution footprint into New England with the purchase of New Hampshire’s Granite State Electric Company and Energy North Natural Gas. In addition, Algonquin Power announced its participation in the Northeast Energy Direct project, a $5 billion natural gas pipeline project that will connect Marcellus production to the Northeast. Algonquin Power went public during the Unit Trust craze in Canada and converted to a C corp. when the Canadian government clamped down on its abuses. In the conversion process, AQUNF cut its dividend in 2009 by 74%, but has been raising dividends since then. The current 5-year dividend growth rate stands at 15.5%. The dividend was most recently increased last June by 10.3%. Based on a $7.70 price for AQUNF (C$10.31 for AQN.TO) and a $0.384 dividend, the current yield is 4.98%. Algonquin Power is expected to earn C$0.43 this year and C$0.50 next. This is slightly less than its dividend, creating a payout ratio of over 100%, but the firm’s trends are positive. Based on its most recent 5-year, $4 billion capital expansion plan, the company is targeting growth in assets and EBITDA of 15% CAGR, EPS and cash flow growth of 7-10% CAGR, and 10% dividend growth rate. More information on its capital plans can be found in its most recent Investor’s Day Presentation pdf. Below is a graph of past and expected EPS, in Canadian Dollars. Source: S&P Algonquin Power is getting lots of love from Canadian stock analysts. For example, BMO Research (Bank of Montreal) recently issued a review reiterating its Outperform rating: Algonquin Power saw its target price increased to C$12.50 from C$11.50 at BMO Research, following an investor day it hosted on December 1. The broker reiterated its outperform view. BMO said Algonquin remains one of its best ideas in power and utility. It also noted that Algonquin is now comprehensively viewing its business from a horizontal and vertical lens to broaden and capture additional growth opportunities. Clear is that this strategy has been successful and expanded its secured opportunity set and provide further support to the 10% dividend growth guidance through 2020, the broker added. BMO increased its EPS estimate to C$0.52 for 2016 while reducing its 2017 forecast to C$0.59. The 2015 outlook remains at C$0.43. BMO is not the only broker who likes Algonquin Power. From Dakota Financial News : A number of other brokerages also recently commented on AQN. RBC Capital lifted their price target on shares of Algonquin Power & Utilities Corp from C$11.00 to C$12.00 and gave the company an “outperform” rating in a research report on Thursday. TD Securities lifted their price objective on Algonquin Power & Utilities Corp from C$11.00 to C$11.50 and gave the stock a “buy” rating in a research report on Monday, November 9th. Scotiabank lifted their target price on shares of Algonquin Power & Utilities Corp from C$11.00 to C$12.00 and gave the stock a “sector perform” rating in a research note on Monday, November 9th. CIBC boosted their price objective on shares of Algonquin Power & Utilities Corp from C$6.50 to C$7.00 and gave the company a “sector outperform” rating in a research note on Thursday, November 26th. Finally, Macquarie began coverage on shares of Algonquin Power & Utilities Corp in a report on Thursday, November 26th. They set an “outperform” rating on the stock. As most international investors know, the sharp spike in the value of the US Dollar has hurt the valuation of its holdings when converted back into USD. For example, the 26% decline in the value of the Canadian Dollar has caused a decrease in dividends paid in Canadian dollars by Canadian firms. When both were at parity, a $1 in Canadian dividends was worth $1.00 in USD. However, currently the same Canadian dollar would translate into $0.734 in USD. Algonquin Power’s unique dividend policy is to pay its dividend in USD for US investors as to make the income portion of an investor’s total return unaffected by the trials and tribulations of the international foreign exchange market. Algonquin Power is able to do this because 80% of its EBITDA is generated in the US and is paid to the company in US Dollars. This attribute should be both a comfort and an advantage to income investors. On the share price side of total return lies an interesting opportunity. If you believe the USD is overvalued compared to the Canadian Dollar, investing in Canadian-listed stocks could provide an interesting boost in potential capital gains. Below is a chart of the US-listed AQUNF (black line) and the Toronto-listed AQN.TO (gold line): The major difference is the slide in the exchange rate starting in Nov. 2013. Over time, if the current exchange rate moves back to parity, share prices should respond positively. However, in the short term, as the US Fed begins to raise rates while the Canadian Central Bank either loosens or maintains its low rates to combat its current commodity-generated economic weakness, the move towards higher exchange rates will favor the US rather than Canada. Insider ownership is substantially larger than most utilities. From Algonquin Power’s tear sheet pdf, insiders own 19.6% of the outstanding stock. Regardless of industrial sector, this level of insider ownership usually connects the retail investor and management at the hip, and should be viewed as a positive attribute. Over the medium term, Algonquin Power should continue to increase its US assets through expansion of alternative power generation and acquisition of smaller US utilities, almost in a roll-up type process. Management’s growing customer base covers the major types of utilities in electric, natural gas, and water services. This allows the company to review opportunities over multiple sub-sectors of the utility sector. Although a cursory review of its dividend history could prove unsettling, I would consider the current dividend supported by management’s growth plan as being a reliable source of income. Investors looking for comfortable utility dividend income and a play on both above-average industry growth and a rebound of the Canadian Dollar over time should review AQUNF. Previous articles on Algonquin Power can be found from Oct. 2014 and March 2015 . I have been long AQUNF since Sept. 2010. Author’s Note: Please review disclosure in Author’s profile. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

A Bullish Case For Dominion Resources

Dominion is down more than 8% over the past one year and 13.9% YTD. Energy Information Administration expects that generation from natural gas will increase from 27.5% in 2014 to 31.6% in 2016. Utility sector forward P/E valuation has dropped to 14.9x, very close to its historical average of 14.1x. The utility stocks have remained the favorite choice for regular income seeking investors with less risk appetite. The utility stocks have posted some impressive gains over the past several years, and valuations expanded significantly. However, Fed’s indication to hike the interest rate has changed the ground and utility in S&P 500 index is now the second worst performing sector, so far this year. Dominion Resources (NYSE: D ), one of the largest utilities in the U.S., has significantly underperformed, just like other utility stocks, as investors adopted a defensive strategy. As a result, Dominion is down more than 8% over the past one year and 13.9% YTD. (click to enlarge) Source: Yardeni Research Dominion’s portfolio mix is well diversified, and it has the generation capacity of approximately 24,400 megawatts along with 12,200 miles of natural gas transmission. However, the largest natural gas storage system capacity of 928 billion cubic feet distinct Dominion from other utility companies. Dominion’s gas storage and transportation operating revenues have surged 7.3% to $1,221 million, or 13.4% of total revenue, so far this year. The storage and transportation revenue will continue to rise in the fourth quarter and next year as demand for U.S. gas in 2015 is estimated to increase by 4.6%. Coal-fired electricity generation has remained the largest component of power generation in the U.S., but the industry dynamics have changed dramatically in the recent past. In April, gas-fired power generation surpassed coal for the first time. In the near-term, Energy Information Administration (NYSEMKT: EIA ) expects that generation from natural gas will increase from 27.5% in 2014 to 31.6% in 2016 amid low natural gas prices. It bodes well for the company as low natural gas prices will reduce the fuel costs and will help Dominion to deliver 5% – 6% earnings growth in 2016. On the other hand, the significant increase in gas demand will fuel Dominion’s gas storage revenue, which will mute the unfavorable impact from the unregulated business. Currently, Dominion produces approximately 34% electricity from natural gas, and coal generation is 27%. Dominion’s 1,358-megawatt combined-cycle plant in Brunswick County, which is expected to become operational in mid-2016 and three-on-one combined-cycle plant with production capacity of 1,588-megawatt Greensville County will increase the share of natural gas generation to approximately 45% by the end of 2018. The declining cost of generation from natural gas and advanced technology will further strengthen the operating margins in the coming years. Moreover, the anticipated contribution from ongoing growth projects including The Cove Point LNG export facility will start fueling earnings growth from 2018 onwards. Thus, these factors completely justify that Dominion’s earnings will grow at an estimated 3-year CAGR of 7.3%, and growth will pick the pace in 2018 due to the addition to major growth projects. Source: NASDAQ With the low natural gas and power prices, the unregulated utility sector’s revenue stream may tumble in the coming quarters. However, Dominion is pretty secure against this headwind as it generates approximately 68.7% of total operating revenue from regulated business and only 16.5% is unregulated. It bodes well for the company as the supportive regulatory environment will enable Dominion to maintain the profit margins while generating steady cash flows. Thus, the growing gas storage business and stable outlook of regulated business will protect the operating margins on stable operating revenues, and will also improve the cash flow to debt ratio from its current level of 15.5%. However, Dominion’s cash flow to debt ratio may remain lower as compared to estimated industry average of 21% for 2016 primarily due to $8.6 billion CAPEX in 2015 and 2016. Dominion’s management is pretty confident to sustain organic growth as the company is deploying quality assets and major projects are on time and budget. The combined-cycle plants and plan for 400-megawatt utility-scale solar generation will pave the way for achieving 80% to 90% operating revenue from regulated business, which will further stabilize revenue stream. Moreover, the management has indicated the there is no need for a big merger deal as the company is well-positioned to meet the future demand while continuing profitable growth. It is a good sign from investors’ perspective because the leverage ratio will remain in its current range of 1.68 times and shareholders will receive 8% annual dividend increase over the next five years. The dynamics are quite favorable for Dominion except the slight drop in electricity demand in the U.S. Moreover, the industry-wide initiatives to reduce the nuclear power production costs by 30% by 2018 also suggests some margin gains for the major utilities. However, the rising yield on 10-year U.S. Treasury note is putting downward pressure on utility stocks, and the interest rate hike is pending yet. The Philadelphia Utility Index (UTY) is already down approximately 16% from its peak at the start of 2015 and Dominion followed the decline. Resultantly, utility sector forward P/E valuation has dropped to 14.9x , very close to its historical average of 14.1x and significantly lower than S&P 500 index forward PE of 15.6x. It is quite an aggressive reaction from investors. Fed has hinted several times that it will follow the gradual and cautious strategy to hike the rate. That said, if it happens, the rate will start increasing from a very low level that Dominion’s yield will still be attractive. Moreover, the interest rate will also increase the ROE, which will partially offset the additional finance cost burden. (click to enlarge) Source: NASDAQ The drop in stock price has pushed Dominion’s dividend yield to a very attractive level of 3.97%. And, now Dominion is trading at trading at a forward PE of 17.1x, significantly less than the 5-year historical average of 36.2x. Thus, it seems that the market has already incorporated the impact of interest rate hike and Dominion may perform well in 2016 as earnings of the company will sustain long-term growth owing to margin expansions and aggregate growth CAPEX of $14.9 billion from 2016 to 2020. That said, Dominion is still a very attractive dividend stock capable of providing upside potential once the dust settles.