3 Undervalued Small-Cap Utilities With A Greater Than 3% Dividend Yield

Includes: CTWS, IDA, PNG
by: Black Coral Research

Valuation of utilities stocks remains relatively in line with historical average levels. The analysts at Goldman Sachs estimate a slight downside potential of 1% to 3% consensus estimate across utilities stocks, largely driven by new, lower electricity demand outlook. Higher long-term interest rates remain a technical headwind for the broader sector, except the independent power producers, and on average, Goldman Sachs expects a 6% return for utilities stocks and 24% for IPPs.

They expect three "themes" for utilities that should capture investor attention this year, including: (1) capital allocation - dividend growth and buybacks, (2) cost reduction efforts following M&A and rate cases, especially in a weak-demand environment; and (3) rate case concerns, with approximately 40% of the sector index facing major rate proceedings and risks to authorized return levels set by regulators.

The chart below illustrates that EPS growth for the Utilities industry remains among the lowest:

Average Earnings Per Share CAGR 2013-2015, by sector

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Source: Factset Research

Even after the recent underperformance of utilities stocks versus the broader markets, the sector maintained its Neutral view by analysts on Regulated Utilities, as the stocks trade in line with historical P/E multiple averages. While weak electricity demand trends weigh on earnings growth, current low interest rates provide valuation support for the Regulated Utilities (like water) as, historically, Regulated Utilities traded at premiums to the broader market during low interest rate periods.

The charts below show that Regulated Utilities currently trade above their historical average P/E multiples, while it likewise trades in line with historical average P/B ratios:

P/E Multiples, 1990 - 2012 Price-to-book, 1990 - 2012

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Source: Goldman Sachs Research Estimates

Below are three utility companies with strong fundamentals, a low valuation, and greater than 3% dividend yield to compensate investors while they wait for a boarder sector recovery.

Stock Valuation Summary

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Source: Yahoo Finance

Connecticut Water Service (NASDAQ:CTWS) operates as a regulated water company out of Clinton, CT.

  • Revenues. Connecticut Water Service achieved revenues of $17.8 million in the fourth quarter of 2013. Analysts polled by S&P Capital IQ forecasted a top line of $18.5 million. Sales were 26% larger than the corresponding quarter's last year at $15.4 million.
  • Margins. Gross margin was 46.9%, which is 10 basis points greater than the prior year's quarter. Operating margin was 23.1%, 40 basis points better than the prior year's quarter. The company's net margin was 8.2%, or 370 basis points, worse than the prior year's quarter.
  • Earnings Outlook. Analysts' average estimate for revenue is $20.7 million. On the bottom line, the average EPS estimate is $0.28. Average estimate for revenue is $91.9 million in the near term. The average EPS estimate is $1.45.
  • Price-to-book Valuations. Price-to-book ratio of CTWS is approximately 1.71X. This is 88.56% lower than that of the Utilities sector, and 97.02% lower than that of the industry P/B. The price-to-book for all stocks is 70.92% higher than the company.

CTWS Earnings Per Share, 2011 -2012

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Source: S&P Capital IQ

IdaCorp Inc. (NYSE:IDA) is headquartered in Boise, ID and owns and operates 17 different hydroelectric generating plants located in southern Idaho and eastern Oregon, as well as 3 natural gas-fired plants situated in southern Idaho. In addition it owns 3 coal-fired steam electric generating plants located in Wyoming, Nevada, and Oregon

  • Revenues. Revenue of IdaCorp rose 5.62% from $250.8 million in the previous quarter.
  • Margins. Gross margin is 39.0%, while operating margin is 23.7% and net margin is 16.1%. Over the past five years, gross margin peaked at 37.9% and averaged 33.4%. Operating margin peaked at 22.4% and averaged 19.1%. Net margin peaked at 16.2% and averaged 13.5%.

IDA Margins, 2008 - 2013

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Source: S&P Capital IQ

Gross margin is 560 basis points better than the five-year average. Operating margin is 460 basis points better than the five-year average. Net profit margin is 260 basis points better than the five-year average.

  • Earnings Growth. Earnings-per-share increased 34% to $0.67 in the quarter versus an EPS of just $0.50 in the year-earlier. By that, the company beat the mean analyst estimate of $0.55 and the average revenue estimate of $253.1 million.
  • Earnings Outlook. Analysts have a more positive outlook for the company's next-quarter performance. Over the past three months, the average estimate for next quarter's earnings has risen from a profit of $0.61 to $0.63. The average estimate is a profit of $3.26 this year.

IDACORP President and Chief Executive Officer LaMont Keen commented: "IDACORP had positive momentum coming into 2013 and we continued on that course in the first quarter, our first quarter earnings demonstrate strong operating performance. The improvement in earnings resulted from general business price changes in 2012, diligent cost management and increased sales due to colder than normal weather during the quarter. No use of additional accumulated deferred investment tax credits, or ADITCs, was required to produce these results."

  • Price-to-book Valuations. Price-to-book ratio of IDA is estimated at 1.38X. This is 90.77% lower than that of the Utilities sector and 70.32% lower than that of the industry P/B. The P/B for all stocks is 76.53% higher than IDA.

PAA Natural Gas Storage (NYSE:PNG) is a Houston, TX based LP engaging in the ownership, acquisition, development, operation, and commercial management of natural gas storage facilities in the United States.

  • Natural Gas Outlook. Reconstructing risk, construction cost overruns, continued low natural gas price volatility and narrow winter-summer spreads pose risks to visible distribution growth.
  • Storage Capacity. While current gas storage market conditions are soft, PAA Natural Gas Storage (PNG) has relatively stable cash flows as the majority of its storage capacity is under firm contracts with third parties, with total remaining weighted average maturity of 2.8 years. At an estimated 95% of calendar 2013 capacity, 80% of 2014 and 50% of 2015 capacity is under contract, which partially mitigates the current soft market conditions and thus supports stability.

PNG Contract Portfolio (% of Capacity Contracted)

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Source: Company Filings

However, PNG is exposed to the risk of lower rates for the 2014 and 2015 storage seasons for uncontracted capacity (April through March). Contracted percentages for 2014 and 2015 are expected to increase by the end of 2013.

  • Price-to-book Valuations. P/B ratio of PNG is estimated at 1.29X. This is 91.37% lower than that of the Utilities sector, and 60.19% lower than that of the industry P/B. The price-to-book for all stocks is 78.1% higher than the firm.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inspire investors. This article was written Hans Centena, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.

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