Recognized as one of the 'Top 40 Best Energy Companies in the United States' by Fortnightly 40, Northwestern Corporation (NWE) is a fully regulated and highly diversified utility company with operations in the states of Montana, North Dakota, South Dakota, Nebraska and Wyoming. The company's energy supply portfolio has tremendous profitability opportunity due to its transmission network amidst re-integration. Even though electricity is the primary utility supplied, NWE also supplies natural gas. In a post-EPA clampdown era, utility companies' priorities now lie with having a reliable grid and diverse product mix.
As mentioned in my previous article, winter will be colder than usual this time around in the United States. The cyclical nature of electricity consumption has called upon a greater use of the utility, while increased tariff for electricity use will generate higher revenues. For Northwestern, majority of its revenue comes from Montana - 84% to be accurate. Over the course of 2014 and 2015, multiple projects are expected to reach completion which will add diversification to its portfolio and stabilize power generation costs.
While Northwestern is a small player in the utility market, Duke Energy (DUK), Dominion Resources (D) and Southern Co. (SO) are market leaders which cater to 14 million electric customers in the U.S. Come 2014, will the bulls side with big utilities, or the small and nimble Northwestern Corporation make a surprise jump?
Financial Stability
Northwestern Corp. reported third-quarter net income of $15.6 million, compared with a net loss of $3.8 million a year ago. The loss in 2012 was primarily related to a one-time project impairment and revenue deferral for the company. The company has been outperforming its initial EPS guidance range for five successive years in which the EPS grew by a staggering 49.5% on average. For fiscal year 2013, the EPS is expected to grow by 5% on a year-on-year basis.
On the other hand, Duke posted its best recorded revenue for the last seven years in 2012, its three year revenue growth stands at 15.5%. The company has reduced its pricing by 2% for North Carolina in the latest quarter, partly because of greater efficiency after Duke's merger with Progress Energy.
Southern Co.'s, cost overruns in construction of Mississippi Power's Kemper County lignite coal plant so far this year have caused an approximate $800 million loss to the parent company. Cooler temperatures in summer 2013 hurt the company's revenues, but now it stands to reap benefit from the cold winter. Revenue trouble is not exclusive to 2013 though, the company's poor run of revenue growth extends back to the past three years.
Only Dominion Resources and Northwestern Corp have managed to have negative revenue growth over the last three years. Unfortunately for Dominion Resources, its net income growth is also in the negative due to excessive costs and low efficiency from operations.
Indicator | ||||
Market Cap | $1.7 bil | $48.7 bil | $36.0 bil | $37.4 bil |
Price/Earnings ttm | 13.0 | 20.5 | 21.4 | 57.1 |
PEG Ratio | 2.4 | 2.3 | 4.2 | 2.6 |
Net Income Growth (3 Yr Avg.) | 10.3 | 18.0 | 9.6 | -38.3 |
Revenue Growth (3 Yr Avg.) | -2.1 | 15.5 | 1.7 | -4.0 |
Dividend Yield, % | 3.49% | 4.48% | 4.93% | 3.49% |
Return on Equity | 13.4 | 5.9 | 8.5 | 5.3 |
Current Price | $43.59 | $68.94 | $40.71 | $64.41 |
(Financials from Morningstar)
On the valuation front, Northwestern Corp looks heavily undervalued compared to the competition. The company has shown consistent improvement in its gross and operating margin, reflected by the compounding annual net income. The PEG ratio also underlines the company's growth prospects for the future while providing a relative valuation. Northwestern and Duke have higher expected growth over the next five years in comparison to Southern Co. and Dominion Resources.
Cash flow from operations in the latest quarter was anything but impressive for Northwestern, due to a decline of 42% on a quarter-on-quarter basis. CAPEX as a percentage of sales has been highest in the bygone fiscal year than ever before. For the prevalent year, quarterly strength in CAPEX looks set to exceed the previous high, while cash flow troubles should not be a concern as the company is already financing its PPL Montana deal. It also plans to close into permanent financing with approximately $450 - 500 million of debt, up to $400 million of equity and $50 million of free cash flows. Liquidity and ease of credit will help shore up funding for the company's prospective projects.
Stock Performance
NWE's numbers represent solid and continued growth; its stock market performance mirrors the company's strong finances. The graphical illustrations below represent the company's performance in comparison to Duke Energy, Southern Co. and Dominion Resources. Furthermore, Dow Jones Utility Average provides a holistic view of the utility industry.
Since 2009, Northwestern's stock price has appreciated by 95%. Add its incremental dividend and the company usurps its rivals in the five year total shareholder return segment. Southern Co. has been a big disappointment over the course of one year and five year growth perspectives. The company lost 13.5% of its value since 2009, while its stock performance tapered off in May this year and continues to be stuck in a freefall. Dominion Resources' financials provide an awful picture, yet its stock performance has been in line with industry leaders for the past five years. It provides a similar dividend yield as Northwestern but unlike its rival it is highly overvalued compared to the utility market.
The 12 month stock performance graph shows a slip in Northwestern's stock price since the start of November. The company's fundamentals are solid, which leaves one wondering about a feasible entry point. Since its large cap rivals have hardly been able to keep up and Dominion Resources is considerably overvalued, risky and volatile, it would be interesting to look for an entry point into this stock. The company managed to minimize expenditures to maintain net income and thus, avoid unfavorable finances. With projects in-line for completion at Northwestern Corp, reintegration of utility provision and increased diversification of energy sources - its current price drop provides a good entry point to buy the stock.
Dividend
Duke Energy's 4.48% yield assures a healthy, consistent return on investment. But the dividend payout has been far from consistent over the past seven years. Despite having a high revenue and net income growth rate, Duke has been unable to maintain sustainable levels of dividend payout. I say sustainable, because while it is a welcome sight to have a company have consistently high payout ratios - it is unsustainable since there is very little reinvestment being done in the company for future growth. In 2012, Duke had a payout ratio of 100.7% i.e. the company paid more to its shareholders than it earned.
Duke Energy | ||||||||
Year | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
Payout Ratio | 44.8% | 74.1% | 71.7% | 89.1% | 114.6% | 97% | 77.3% | 100.7% |
Northwestern Energy | ||||||||
Year | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
Payout Ratio | 58.5% | 124.0% | 88.9% | 74.6% | 65.9% | 63.9% | 56.4% | 55.4% |
Southern Co. | ||||||||
Year | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
Payout Ratio | 69.3% | 73.1% | 70% | 74% | 80.7% | 74% | 71.3% | 70.7% |
Dominion Resources | ||||||||
Year | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
Payout Ratio | 89.3% | 62% | 35.4% | 50% | 80.7% | 36.4% | 80.4% | 370.2% |
Northwestern Energy is maintaining a stable level of payout ratio and continues to improve dividend values for its investors. While it would be preferred to see the company payout in the 60-70% region, the low payout ratio is understandable for a small-cap company as long as it is being re-invested. The re-investment prospects are mentioned later in the article.
However, Southern Co. is the pick of utility stocks for dividend payments. Its 4.93% yield and an increasingly stable payout ratio instills trust. As long as the company manages to maintain its current dividend payout, investors will be largely happy with this dividend stocks. Sadly though, its future prospects are not lighting up as brightly as perhaps Northwestern Energy.
Future Prospects
Northwestern recently announced a $900 million agreement with PPL Montana to purchase 11 hydro-electric dams in Montana. The company owned only between 25% and 30% of the resources it used to provide electricity to its customers. After the 633 megawatt addition of hydro power, the utility company's resource ownership now stands at more than 60%.
This means that NWE will be less susceptible to swings in the energy market. That, combined with the flat cost of operating hydroelectric power generation, means greater long-term rate pricing stability. Furthermore, half of the company's total needs in Montana can now be met by hydro and wind generation.
Montana's state law requires 15% of a utility company's energy supply to come from renewable energy by 2015. After the acquisition of 11 dams from PPL Montana, the company produces 56% of its total electricity from renewable resources, as illustrated in the figure below.
Furthermore, Big Stone equipment and Neal pollution control equipment are expected to be completed in 2014 and 2016 respectively. These measures will not only shield the company from legislation change on environment protection but make market prices for coal and gas an exogenous factor, since only 30% of the electricity is produced by those avenues.
Competition
Duke Energy is working on building three solar plants in Eastern North Carolina. The project's pilot became effective on December 29. At the same time, it is forwarding a plan to decommission its already shuttered Crystal River nuclear plant. The two ventures will be costly as the decommissioning alone will cost around $1.18 billion.
Southern Co.'s $5 billion project in Mississippi is one of the first coal-fired power plants that capture carbon dioxide emissions. Unfortunately, the company has faced a series of cost overruns and delays. Not only will Southern lose output during the delay; it also stands to miss out on $133 million in tax incentives on which it agreed with Mississippi regulators earlier this year. Couple that with SO's meager revenue growth and high valuation, and the stock starts to look unattractive.
On the bright side, the company is investing largely in renewable energy as a total of 1,700 megawatts was added in 2012 alone. The company continues to ponder moves for Georgia solar projects which will take consider time before completion and operational rewards can be reaped by investors.
A fuel cell facility and solar farm in Connecticut are Dominion Resources' latest addition into its power production mix. Furthermore, three solar farms in the Indianapolis area were also started early in December as the company moves towards more efficient production measures and diversify its goal dependent portfolio.
The big utilities are slowly moving towards solar and renewable energy solutions - which is good for the environment and electricity bills, but this does not provide a boost of positive performance on the stock market.
Summary
While Northwestern's strong profitability underlines its potential for future investment, the deciding factor has to be based on its ability to nurture organic growth. Northwestern's move to acquire hydro-electric assets from PPL Montana looks to be an inspired move. Its renewable energy dependent energy mix and incrementally improving financials make a very strong case for investment into the company.
I believe the share's price will appreciate drastically by the time its new hydro-powered assets come online in 2014. The price drop since November makes the current price a suitable entry point into a stock which has appreciated almost 100% over the past 12 months. Making Northwestern a part of your portfolio is not only a prudent decision, but a long-term sure shot.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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