The utilities sector is one of the main sectors of the economy and is made up of companies such as electric, gas, and water utility firms. Utility stocks are generally not high growth stocks that will outperform the market, but rather high yielding equity investments. These companies require significant infrastructure and therefore often carry large debt loads. Due to these large debt loads, utility companies are sensitive to interest rates and subject to the risk that follows. As a result, higher interest rates mean a higher cost of capital.

The Garnet Group will invest in the utilities sector for two main reasons: to provide the fund with income through a high yielding dividend, and to better diversify our portfolio as we are currently underweight in this sector.


When evaluating utility companies, there will be certain criteria and risks that we take into consideration. Our primary criteria for investment will be the dividend yield. As we look to provide the fund with a source of consistent income, the high dividend yields the sector offers are the most attractive the attribute. We will only invest if the price is right to increase the overall return of our investment and we will also take the company’s debt load into consideration as we weigh interest rate risk going forward in a rising rates environment. Lastly, our investment criteria will take how much renewable energy production the company generates into consideration. As we move towards more environmentally friendly power production, we will look for a company that is already using renewable energy. As laws and regulation that advance this agenda continue, we want to avoid investing in a company that will require significant capital expenditures to abide by new industry standards.

 

Companies

Dominion Energy (D):

Dominion Energy dominates the American energy market as one of the top producers and transporters of electricity and natural gas. It serves more than 6 million utility and retail energy customers across 12 states with concentrations in OH, VA, WV, and PA. Dominion operates through three main segments: Power Generation (60% of revenue), Gas Infrastructure (20% of revenue), and Power Delivery (20% of revenue).

Dominion’s non-renewable energy generation facilities are located in CT, PA, and RI with the that production being concentrated in New England. The renewable energy generation facilities include fuel cell generation in CT, solar generation facilities in IN, GA, CA, NC, SC, TN, UT, and CT, and wind generation facilities in IN and WV.

Dominion is currently following a 5-year investment plan of $8 billion from 2018-2022. Solar projects have emerged as the main source of investment at Dominion as it looks to continue to diversify its portfolio of fuel sources, which include nuclear, coal, oil, solar, and other renewables. Dominion has pursued several mergers and acquisitions since 2013. Highlighted transactions include Scana Corporation for $7.9B, Questar Corporation for $4.4B, and $356MM on several wholly-owned merchant solar projects.

The company has seen boosts in revenue from its acquisitions as well as cuts to the corporate tax rate. In 2017, Dominion’s cash on hand declined by 50% YoY to $120MM, the lowest since 2012. In contrast, cash from operations rose to $4.6B and cash from financing provided $1.3B. Capital Expenditures showed a $6B outflow of cash.

NextEra Energy (NEE):

NextEra Energy is moving its power into the future. The holding company is made up of Florida Power and Light (FPL) and NextEra Energy Resources (NEER). FPL serves 5 million customers in Florida while NEER generates nearly 20,000 Megawatts of modern energy via wind and solar production making it one of the world’s largest producers of renewable energy. FPL operates in southern FL while NEER has assets in nearly 30 US states, 4 Canadian provinces, and in Spain.

Despite the outreach of NEER, 2/3 of revenues come from FPL. NEER contributes to 30% of revenues with rest attributable to other activities. FPL’s revenues come from the sale of electricity to retail customers, 90% of which are residential. FPL produces 70% of its energy from oil/gas sourced power plants, 20% from nuclear plants, and the rest from coal, oil, and solar. NEER, on the other hand, generates revenue by selling to wholesale customers throughout the US and Canada. NEER owns, develops, constructs, manages, and operates electric generating facilities. Approximately 80% of NEER power is contracted out for sale through long-term purchase agreements.

NEE’s FPL has a 2017-2020 budget of $18B to pursue strategic endeavors. On January 31, 2019, FPL announced the start of operations at its four newest solar power plants, building on the mission of advancing affordable clean energy. NEER is considered to be the growth generator of NEERas it wants to be the leading American clean energy company and is humming along with the excellent progress. NEER is beginning to utilize the same technology used in batteries to increase the use of renewables. When completed in 2019, it will sell power to the Tucson Electric Power Company. It is also anticipating growth of its natural gas pipeline business.

Duke Energy (DUK):

Duke Energy serves 7.6 million customers throughout the southeastern United States. They generate 50,000 Megawatts of electricity annually primarily from coal, nuclear and natural gas sources. The company also boasts a small renewables profile, generating clean energy through utility-scale wind and solar assets.

Duke has three main business sections: Electric (90% of revenues), Gas, and Commercial Renewables. The electric utility business encompasses the whole cycle of generation, transmission, distribution, and sale of electricity. The source of energy is well diversified with more than 25% coming from coal, nearly 30% from nuclear, more than 20% from natural gas and oil, and just 1% from renewables.

Duke has shown very consistent business with revenue of around $22B the last several years, only fluctuating no more than 2% each year. The company is currently halfway through a multiyear portfolio transition. It began by focusing on geographic location, selling its international business in 2016. Duke has plans to spend $6B from 2017-2022 to increase its gas business from as a percent of revenue from 5% to 15% over a decade, which its 2016 acquisition of Piedmont boosted. Also in its capital improvement program is a $30B investment in its electric business with around $13B going towards grid upgrade plans with an emphasis on natural gas and clean energy generation. Duke has begun to deploy that capital as a new 560-Megawatt plant is scheduled to come online in late 2019, to help retire it coal-fired units.

The company also proposed the Green Source Advantage Program, a renewable energy project aimed to help large commercial and industrial customers meet their sustainability goals. This program is still waiting approval in select states. Duke also utilized the acquisition of 3 solar power projects to increase its capacity by 50% in California. It also acquired REC Solar, a provider of renewable energy solutions for commercial customers.

 

Market Valuation and Other Considerations

Dominion Energy Duke Energy NextEra Energy
Market Cap $58.98B $64.15B $87.58B
P/E 17.2x 18.9x 21.6x
Dividend Yield 4.69% 4.00% 2.42%
EV/EBITDA 11.2x 11.4x 12.6x
Return on Invested Capital 4.80% 4.18% 8.94%
Return on Assets 3.17% 2.08% 6.60%
Net Income Growth (5 Year Compounded) 8.26% 1.51% 5.23%
Net Debt/EBITDA 6.3x 5.9x 4.4x
Sustainability Rank 34.48 37.24 55.17
5 Year Annualized Total Return 4.61% 9.07% 17.87%
1 Year Total Return 1.80% 21.96% 24.39%
Beta 0.48 0.24 0.37
Source: Bloomberg as of 2/13/19


Investment

The Utilities sector’s weighting of the S&P 500 is approximately 3%, which we aim to replicate in our portfolio for tracking the index as a whole as well as providing income. This translates to an approximate $15,000 transaction that we will allocate between two companies. We would like to buy 40 shares of NextEra Energy ($NEE) for approximately $7,300 because the company carries a relatively low debt load and shows strong signs of future growth in the renewable energy space. We would also like to purchase 110 shares of Dominion Energy ($D) for approximately $8,000 primarily because of the higher dividend yield but also because it is a more diversified business generating more revenue from different business segments.

by Rory Nizolek ’19