Wednesday, July 8, 2015

Sector Overview – Utilities

The utilities sector has seen a fair bit of correction as investors have sold off this bond-substitute as the interest rate jitters took hold of emotions. The Utilities SPDR ETF (XLU) is down approx 9% YTD. This has pushed the valuation to attractive levels for some utilities and I am looking to initiate positions in this sector. Regular readers of this blog are familiar that I recently sold my position in a utilities ETF (BMO Utilities ETF – ZUT.TO) that had exposure only to 12 companies and all exposed only to the Canadian economy. There were a few other reasons for selling that ETF – one of the main ones was the fact that I wanted dividend growth from my holdings. In my quest to narrow down utilities and find one to invest in, I have been doing some research and decided to share the details on how I am narrowing down my pickings. This way, you can see how I am picking my investments. Feel free to share your thoughts and comments below.

Note that the tables below show the data that interests me. The columns are extracted from Dave Fish and Michael Weber’s CCC lists. Other investors may give more weight to other metrics (including myself). While this exercise is supposed to help me narrow down companies to research, I may go back and revisit the whole list and start looking into researching even if it failed on one criterion which caused it to get dropped from the list.


Chowder Rule: Named after “Seeking Alpha” member Chowder, this is a method of identifying candidates for purchase based on a combination of yield and (5-year) dividend growth rate. When the sum of these elements is above 12%, the company presents an attractive entry point (8% for utilities). When the figure is above 8%, an existing holding is still considered worthy of being retained. Caution: This ‘Rule” is intended to be used in conjunction with measures of quality, such as high marks for safety and financial stability, as specified by organizations such as Value Line or Morningstar.

Est 5-yr Growth: is the expected earnings growth rate for upcoming five years, according to analysts.
Confidence Factor: indicates the confidence in continuation of dividend increases – see Dave Fish’s CCC list for scoring system details in the ‘Notes’ tab. Numbers range from 1 to 102.

Step 1 – Starting List

I started off with Dave Fish’s CCC list that contains data for all dividend growth companies that have raised dividends for atleast 5 years. I have also added the utility companies in the Canadian market taken from the Canadian All-Star List maintained by Michael Weber. From these two lists, we get 62 companies in the utilities space – which is a huge list and needs to be trimmed and narrowed down for further research.

In the 56 companies from Dave Fish’s CC list, there are 17 Diversified Utilities (electric & gas), 12 Electric-Only, 16 Gas-Only, 9 Water Utilities, and 2 Other.

In the 6 companies from Michael’s All-Star list, there are 4 Diversified, 1 Electric-Only, and 1 Other
Total Companies: 62

Step 2 – Duplicates & Small Caps

There is one duplicate in the list – Brookfield Infrastructure Partners LP (BIP, BIP.UN.TO) – so I remove the Canadian listed duplicate.

In the Canadian list, I remove Atco Ltd (ACO.X.TO) – which for most purposes is the same as Canadian Utilities (CU.TO) except for higher exposure to Atco Structures & Logistics – see the Corporate Structure here.

By investing in utilities, I am looking for income stability and in the past I have normally stuck with larger companies for most of my investing needs. While the utilities sector is probably different – esp since its a regulated industry, I still remove small caps from consideration. Considering only Mid Cap and over ($2B+) companies results in 15 entries being removed.
Total companies remaining: 45

Step 3 – Chowder Rule

The Chowder Rule normally states that a good opportunity exists in companies which have a Chowder value of 8% or higher. Considering that we are in an environment where getting any yield is hard and prices have been driven up, I decided to relax this rule from 8% to 7%. Even after relaxing the rule to 7%, we lose some high quality large cap companies that are popular with most dividend growth investors such as Consolidated Edison (ED), Duke Energy Corp (DUK), SCANA Corp (SCG), PPL Corp (PPL) etc. Nevertheless, I remove them from the list.
Total companies remaining = 30

Step 4 – Payout Ratio

I remove companies with extremely high & unsustainable EPS payout ratios. Instead of simply removing based on a flat number of payout ratio, I also take into account what the expected EPS growth over the next five years according to analysts. Here I remove APU, which has a payout ratio of 371% and an EPS growth estimate of 2.2%; BIP has payout ratio of 175% and EPS growth est of 0.6%.

Two other candidates for removal are Dominion Resources (D) and Southern Company (SO). Dominion has 103% payout ratio, but has a decent EPS growth rate estimate of 5.9%. However, it appears that the dividends have also been growing at the same rate (see the dividend growth rates (DGR)), so I expect those dividends to slow down considerably over the coming years unless the EPS rises faster. Dominion also seems to be most overvalued compared to the Graham Number values. Southern Company has 92% payout ratio and EPS are expected to grow 3.3% for next five years. Again, this is in the ball park of the DGRs for SO. The good thing about SO is that it yields almost 5%, so its unrealistic to expect faster DGR. I have decided to leave D and SO in the list for now.

Total companies remaining = 28


Some notes from the list of 28 companies:
  • The longest dividend increase streak is Canadian Utilities (CU.TO), with Fortis Inc (FTS.TO) coming a close second.
  • Southern Company (SO) and Brookfield Renewable Energy (BEP.UN.TO) have the highest yield (~5%).
  • Wisconsin Energy (WEC) and CMS Energy (CMS) take the crown for best Chowder Rule numbers (~20%). Both payout about 2/3 of their earnings in dividends (~3.5% yield), have good EPS earnings growth estimate of 5.8% and 6.7% respectively.
  • Lowest yielding company is ITC Holdings (ITC) at 1.8%, but also has the highest EPS growth rate estimate at 11.9%
  • Lowest EPS growth rate estimate goes to CenterPoint Energy (CNP) at 1.9%
  • As per the Graham Number values, Dominion (D) is the most overvalued and Westar Energy (WR) is the most undervalued.
  • Confidence factor: Highest for NextEra Energy (NEE) and lowest for Dominion (D).
  • All things considered, I think its safe to say that Dominion (D) should be dropped from the list. I will be looking into the rest of the companies and look for qualitative aspects and advantages they may enjoy over peers.
What are your thoughts on the process and the shortlist? Are there any particular utility companies that I need to pay attention to – either from the final list of 28 or from the ones that were removed? Share your thoughts below.

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