Assessing Utilities

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Assessing Utilities

Post by JaydoubleU » 24 Jan 2010 20:32

When assessing stocks, I assume there may be different criteria to consider depending on the sector. Some say that "ABC has a high debt/equity ratio vs XYZ," however utilities generally do carry higher debt loads than other kinds of companies. My question is, what to look for when assessing them? I have been looking at a number of these and finding it hard to distinguish one from another.

For instance, how to we distinguish FTS from EMA, or National Grid from Exelon?

Cheers.

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Re: Assessing Utilities

Post by brad911 » 25 Jan 2010 01:03

I tend to assess both from a general stance (how I approach any company) until I get down into the debt. There I'm more concerned with their ability to service the debt and/or pass along the increased costs of added debt to customers (things like higher margins). I own both FTS and EXC. Part of being comfortable with the amount of debt each holds (which is different due to their business models) deals quite a bit with my confidence in management to handle the debt over the short & long-term. Have they done it well before, is debt within the historical range, are they stretching themselves too thin without adding needed equity.
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Re: Assessing Utilities

Post by Mike Schimek » 25 Jan 2010 02:36

I owned NRG for a little while but honestly didn't know much about it. Bought it in part because it was cheap and Buffet was loading up on it and I wanted to own cheap, tangible asset like companies at the time. Figured Buffet did my homework for me. Tried doing in depth research on it and gave up because of the enormity of the task; was out of my league.

Did something similar on Boralex income fund. I think I chose not to buy in at some point because of some weird contractual agreement with the U.S. for their U.S. generated power whereby they have to sell it really cheap in the future. Also some wood residue problems with some of their power plants. I wonder if they took all their crappier power plants and dumped them into an income trust to sell it off to the masses of hungry suckers that were frothing at the mouth to buy income trusts at the time.

My guess is that the bigger utilities are relatively safe from "weirdness", but the small ones require a lot of DD and it is important to scrutinize every minute detail. Particularly if it's an income trust, because income trusts were often partial asset spinoffs, with management of the parent corporation doing the spinoff in order to milk the frenzied demand for income trusts at the time.

IMO take a good look under the hood in these cases and don't trust the odometer or the used car salesman, do lots of DD.

I think that presently if I wanted to buy a utility company, I'd just take a look at which ones Buffet owns and buy that one, particularly if the price hasn't moved up too much since his last purchase.
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Re: Assessing Utilities

Post by scomac » 25 Jan 2010 09:04

One of the clearest distinctions between various utilities will be whether or not the operate in a regulated or unregulated market. Most will have exposure to both segments, but there will be differences in the percentages of revenues from regulated versus non-regulated sources. The security of the regulated markets leads to more certainty with respect to operating results and growth thus usually leading to higher multiples. Examples of this distinction would be EMA which is 100% regulated versus TA with its predominantly non-regulated revenues on the power generation side.

In terms of the capital side of the business, do the various contracts match up well with financing commitments? What's the future capital demand likely to be based on the quality of the assets? How dependant are future expansions on current demand versus some as yet realized future demand (incremental or totally new source) from your customers?
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Re: Assessing Utilities

Post by Peculiar_Investor » 25 Jan 2010 09:14

scomac wrote:One of the clearest distinctions between various utilities will be whether or not the operate in a regulated or unregulated market. Most will have exposure to both segments, but there will be differences in the percentages of revenues from regulated versus non-regulated sources. The security of the regulated markets leads to more certainty with respect to operating results and growth thus usually leading to higher multiples. Examples of this distinction would be EMA which is 100% regulated versus TA with its predominantly non-regulated revenues on the power generation side.

In terms of the capital side of the business, do the various contracts match up well with financing commitments? What's the future capital demand likely to be based on the quality of the assets? How dependant are future expansions on current demand versus some as yet realized future demand (incremental or totally new source) from your customers?
Fortis (FTS) is another example like TA,
Fortis Inc. wrote:Fortis Inc. is the largest investor-owned distribution utility in Canada, serving more than 2,000,000 gas and electricity customers. Its regulated holdings include a natural gas utility in British Columbia and electric utilities in 5 Canadian provinces and 3 Caribbean countries. It owns non-regulated hydroelectric generation assets across Canada and in Belize and upper New York State. It also owns hotels & commercial real estate in Canada.
When I looked at FTS as an utility investment, I struggled understanding how management's competence included running a distribution utility and hotels and commercial real-estate. It brought back memories of Bell's de-worsification into Montreal Trustco and other non-core businesses.
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Re: Assessing Utilities

Post by JaydoubleU » 25 Jan 2010 18:27

Txs for the replies. Lots of helpful comments.

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Re: Assessing Utilities

Post by Sensei » 25 Jan 2010 21:22

Hi,

Interesting question and one which isn't talked about much lately. The companies are too boring, I guess.

OTOH, I've been reading about and acquiring utilities at a faster rate than just about any other type of stock.

I own Duke, Southern, Piedmont, Exelon, AGL, and Westar in the US and National Grid which straddles both the US and UK. Except for Piedmont, most of these choices have been inspired by reading Morningstar and Argus research.

I think most of my utilities meet most of these criteria which are also talked about in books like 'The Single Best Investment' and 'The Ultimate Dividend Playbook':

1. high credit quality
2. 50% debt to equity or less
3. payout ratio can be up to 70%
4. good relations with regulators
5. mix of regulated and unregulated businesses (I prefer mostly regulated)
6. sensible diversification and acquisitions (Read: sensible management)
7. middle initial yield (4-6%)
8. reasonable dividend growth (4-5%)

Of course, after an anomalous, 2009 it is difficult to discern what the long term trends will be, so none of these may be good choices going forward. For now, though, they are paying a decent dividend income which appears to be sustainable.
Cheers

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Re: Assessing Utilities

Post by ttomaj » 27 Jan 2010 20:48

I agree that some people view them as boring, but I find that I typically include utilities in all of my model portfolios. They are generally good dividend payers and for people looking for income from their portfolios, they could make a good component. When looking at utilities one of the most important thing I look out for is debt coverage ratios (how much debt service versus free cash flow). Generally, the lower the debt the better. This debt service ratio might be a good proxy for knowing how safe the dividend distrubtion is.
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Re: Assessing Utilities

Post by kenwood » 30 Jan 2010 13:10

I often view utilities as no-to-low growth and staple companies and I would make my investment decision based on dividend growth and sustainability prospect.

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Re: Assessing Utilities

Post by Sensei » 31 Jan 2010 01:11

Hi,

Does anyone use http://www.dividendinvestor.com or http://www.dividendinvestors.ca? Their payout ratios always seem to be at odds to what I find elsewhere. I noticed this especially when I started checking utilities to see if they really met my own criteria! Any ideas?
Cheers

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Re: Assessing Utilities

Post by Arby » 19 Nov 2010 12:15

TDWH recently revised the method they use to determine their target price for utilities. Previously TDWH derived their target price based on 50% P/E, 25% dividend yield, and 25% P/B. They have changed their methodology due in part to implementation of IFRS accounting, which they say will cause investors to focus more on cash considerations when valuing utilities. Their new methodology is based on 50% FCF yield, 25% EV/EBITDA, and 25% dividend yield. I think investors in utilities place a much higher emphasis on dividend yield than the 25% used by TDWH.

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Re: Assessing Utilities

Post by scomac » 19 Nov 2010 12:23

Arby wrote:TDWH recently revised the method they use to determine their target price for utilities.
Looks suspiciously like an effort to complicate things in order to give the impression that their analysis is more valuable. :roll:
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Re: Assessing Utilities

Post by MaxFax » 20 Nov 2010 11:52

I think the new accounting rules allowing the valuation of assets using the company's own 'value in use using their own set discount rate' will have HUGE impacts on the way companies are evaluated. The whole concept of ROE will get thrown out because companies predetermine it by their asset valuation.

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Re: Assessing Utilities

Post by Wallace » 16 Aug 2017 20:48

I've resurrected this 2010 thread because I'm thinking of adding an electricity-generating utility to my portfolio. It's interesting to see the above comments in light of everything that's happened since 2010.
I'm looking at Fortis, Canadian Utilities, ATCO, and any others you might suggest. Fortis seems a steady performer with a stable, increasing dividend over 25 years. My first thought is to go with FTS. Canadian Utilities seems interesting too, P/E lower at 18.2, 3.67% div yield, 2.2 P/B, with good EPS growth. ATCO seems very similar.
I guess the ones to avoid are the ones heavily invested in coal plants. But solar seems to be holding some of them back too. Northland Power Inc (NPI) is heavily invested in wind, with thousands of turbines along highway 21 in Ontario next to my cottage. They're coming on strongly, but have a high (82.5%) debt ratio. I think I'll give Hydro one a miss.
Any thoughts?
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Re: Assessing Utilities

Post by BRIAN5000 » 16 Aug 2017 20:54

You haven't mentioned Emera (EMA.TO)?

I haven't looked at Fortis since the acquisition I use to class it as half pipeline & half power generation?
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Re: Assessing Utilities

Post by Thegipper » 16 Aug 2017 23:11

Wallace wrote:
16 Aug 2017 20:48
I've resurrected this 2010 thread because I'm thinking of adding an electricity-generating utility to my portfolio. It's interesting to see the above comments in light of everything that's happened since 2010.
I'm looking at Fortis, Canadian Utilities, ATCO, and any others you might suggest. Fortis seems a steady performer with a stable, increasing dividend over 25 years. My first thought is to go with FTS. Canadian Utilities seems interesting too, P/E lower at 18.2, 3.67% div yield, 2.2 P/B, with good EPS growth. ATCO seems very similar.
I guess the ones to avoid are the ones heavily invested in coal plants. But solar seems to be holding some of them back too. Northland Power Inc (NPI) is heavily invested in wind, with thousands of turbines along highway 21 in Ontario next to my cottage. They're coming on strongly, but have a high (82.5%) debt ratio. I think I'll give Hydro one a miss.
Any thoughts?
I would be looking at FTS, Emera and AQ.

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Re: Assessing Utilities

Post by JaydoubleU » 17 Aug 2017 08:35

I would be looking at FTS, Emera and AQ.
Do you mean AQN, Algonquin?

In a rising rate scenario, I think one would want a utility that offers significant growth, less relative debt, and, as you mentioned, less exposure to old technologies (ie coal; ignoring the Trump pro-coal stand, which I doubt will hold out against the cost advantages of natural gas and renewables.)

My first choice would be Algonquin, because it is very diversified among wind, solar, hydroelectric and gas, and it also has water distribution and wastewater treatment. It is also reasonably balanced between regulated and unregulated utilities. It has a strong presence in the US and pays dividends in USD, targeting a 10% annual growth rate. Since I bought it in 2014, I think they've raised he dividend four times.

Among the larger utilities, I like the ones that have a clear development plan towards renewable power, and my choice here would be Emera. EMA, to quote from its website, has a "strategic focus on transformation from high carbon to low carbon energy sources. Emera has investments throughout North America, and in four Caribbean countries. Emera continues to target having 75-85% of its adjusted earnings come from rate-regulated businesses." The regulated aspect is important in a rising rate or inflationary environment. I like their Bay of Fundy tidewater project.

Fortis, of course, is the giant in the room, and I don't think you can go wrong with it. They tout 93% regulated utilities. I'm not sure quite why FTS isn't my first choice, however. Perhaps because it is already so large and so stable that there seems less room for growth than with an AQN, other than by large, expensive acquisitions. And Fortis is never cheap; in fact, it is downright pricey now at $46 and change. So you get your 3.5% dividend and then wait for the end of time for the growth to happen. FTS was a great one to pick up at bargain in 2009 and then just hold forever. But in 2017, I prefer one that has a 15-20% upside and meaningful dividend + dividend growth.

Not much else to say: I'd like to see a little more M&A activity in the Canadian space. There are plenty of smaller entities such as NPI, BLX, INE, or RNW (majority owned by TA) that could be taken out eventually.

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Re: Assessing Utilities

Post by Wallace » 17 Aug 2017 20:15

Thanks, all, for the suggestions. Jay, how do you work out that Fortis is overvalued? The analysts certainly agree with you, putting the target price at just over $41 compared to its present $46. But its P/E is 20.3 compared to 26.5 for Emera and 33.2 for Algonquin. I realise that the last two may have better growth prospects accounting for some of the difference. P/B is 1.4, 1.6, 1.9 respectively. Maybe they're all overvalued, or investors are anticipating an increased need for electricity in the future.

There were some comments on the electric cars thread about the need for the grid to supply up to 60% more electricity if electric cars come to pass. I was out for a drive today and saw (and followed) my first Tesla. My, could that thing move! And it looked pretty cool, too.
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Re: Assessing Utilities

Post by JaydoubleU » 18 Aug 2017 08:31

Jay, how do you work out that Fortis is overvalued?
Sorry to say that there are no advanced analytics in action here, merely steady observation over the last 10 years. I see Fortis pushing up against 52-week and all-time highs while the others have come off a bit since the rate rise scare (actually, EMA has come back a bit). I also watch the yield carefully, as a measure of relative valuation. FTS spiked to 4.6% back in 2014, but has mostly yielded under 4% over the last 7 years. EMA has yielded as high as 4.75% (in 2013), so the current 4.4% looks reasonably attractive. AQN actually looks pricey by this measure, since it offered yields over 6% in 2016 and is now down to 4.4%.

TDW gives me an AFFO yield of 4.5% for FTS, and 7.0% for EMA. I find these numbers quite low. I like to see AFFO yield closer to 10%, but EMA is cheaper by this measure.

What else? EMA has paid 0.5225/quarter now for five consecutive quarters, so it is probably due an increase, maybe next quarter. An 8% increase--as promised--would bring the yield up to 4.75%, which is at its 7-year high.

Sounds as though I have gradually talked myself into electing EMA as the best pick. (TDW agrees with me in its latest "Pipelines and Utilities" report.)

A couple of other observations. Utilities have experienced what I've been calling a "golden age" for the last 10 years thanks to rock bottom rates. I wonder if this is now coming to an end? Actually, I am in the camp that believes rates will not rise by much in the coming years, because inflation isn't really there, and there isn't too much pressure on wages, either. The demographic wave of aging populations worldwide is going to put downward pressure on economic growth but there'll be continuing high demand for high-income products, especially dividend growth stocks.

As for electrification, I have also wondered how the world is going to cope if the expected transition to millions, and then billions of electric cars take place. Countering the explosive demand on electrical utilities might be the falling costs of individuals owning their own power-producing systems, namely rooftop solar. I don't see so many in Canada, but they are everywhere in Japan; almost every new building now comes with a rooftop solar system that can pretty much power the house and a car (two of my friends have these, but not the car--yet; they sell excess power back to the grid).

Anyway, pardon the amateur economics. You could always go with ZUT and own them all (and many others), but then ZUT only yields 3.77% and I'm not sure of its dividend growth history.

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Re: Assessing Utilities

Post by Koogie » 18 Aug 2017 09:50

JaydoubleU wrote:
18 Aug 2017 08:31
Anyway, pardon the amateur economics. You could always go with ZUT and own them all (and many others), but then ZUT only yields 3.77% and I'm not sure of its dividend growth history.
I own ZUT in my TFSA. Have been happy with it (but I bought it mostly on the cheap a couple years ago). Dividend appreciation has been slow but steady.
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Re: Assessing Utilities

Post by Wallace » 29 Aug 2017 15:06

Decided on Algonquin and Emera. Bought AQN today on the US side but I'll keep the cash for Emera sitting for a while. I always get antsy at this time of year, remembering 1987!
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Re: Assessing Utilities

Post by Profit not Prophet » 30 Aug 2017 09:15

Mawer, mutual fund managers, had a story on this sort of thing in their insights. They had some German nuclear plants and then came the political side of Fukushima. It's called the 'stroke of the pen risk'. I thought this sort of quasi black swan thing might be good to include int he discussion.

http://artofboring.com/stroke-of-the-pe ... 1444187219

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Re: Assessing Utilities

Post by JaydoubleU » 11 Sep 2017 10:57

I could post this link in a number of different places, but Wallace's recent comment that " the need for electricity is going nowhere but up" makes me think that this thread is an appropriate place:
Almost 80 percent of the global auto market is pushing toward phase-out of petroleum cars and adoption of electric vehicles
https://www.bloomberg.com/gadfly/articl ... ping-point

Of course, this doesn't necessarily mean that electricity production is not going to come from coal, heavy oil or natural gas, but since China and India are also working aggressively on adoption of renewable energy, I'd say there's going to have to be one helluva surge in solar and wind production to meet the demand from these future cars:

http://blog.ucsusa.org/rachel-cleetus/r ... hina-india

http://www.reuters.com/article/us-renew ... SKCN18B2Q9

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Re: Assessing Utilities

Post by AltaRed » 11 Sep 2017 11:13

Maybe, but I don't think anyone has anticipated what it is going to take to build new electrical transmission and distribution capacity. There is lots, maybe more, NIMBYism with electrical transmission ROW as there is for pipeline ROW. Landowners absolutely hate transmission towers taking up land and absolutely hate the sight of all those wires. imagine urban dwellers having to look at even more transmission, distribution and substations!

ISTM no one has connected all the dots.
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Re: Assessing Utilities

Post by JaydoubleU » 11 Sep 2017 11:36

well, we're talking years and decades here. The main point is the decisions of governments to take steps, announce policies, lay out plans, with China becoming the latest and most significant.

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