It's been almost five months since we've decided to embark in increasing Grandma's income to help fund her future care. We are almost ready to make our next investment and wanted to review where we've been and our plans going forward. To see where we started, you can see our first article here. We had an unexpected change in the portfolio which I discuss here.
After our first purchases were made and any dividends reinvested, we ended up with this portfolio:
Darden Restaurants (DRI)
General Mills (GIS)
Lockheed Martin (LMT)
Altria Group (MO)
The dividends she's received already exceeded the interest she would have received for the next several years if left in her savings account. COP, finally, announced a dividend increase as well as LMT. DRI announced an increase just before we bought our position so we already started at the higher rate. With the current indicated dividends, our expected income for the coming 12 months has climbed from $238.84 to $248.10, a 3.8% increase and close to our goal, excluding our next purchase.
Thanks to the ongoing market climb, we've also enjoyed a 13% capital gain including the reinvested dividends.
ConocoPhilips' earnings are slowly climbing as they continue their restructuring towards an exploration & production company focusing on North American production.
Darden Restaurants is still struggling with comps and the effects of the recession. Management has had a shakeup but I believe there's still work to be done. I still have hope for improvement. A friend recently had to bring his daughter and a crowd of family and friends to the nearest Olive Garden 20 miles away for a birthday dinner. I'm still concerned with DRI's performance so we'll watch the next several earnings announcements carefully before deciding on any actions.
General Mills is continuing with introducing new products and product extensions. They recently affirmed 2014 earnings expectations and are estimating lower input cost inflation in the year ahead.
Lockheed Martin is still performing as expected and the F-35 Strike Fighter program seems to be gaining interest both in the U.S. and abroad.
Altria Group is continuing with its plans to enter the e-cigarette market and working on reducing some of its debt load with its restructuring efforts. Analysts are expecting margins to increase over the near term due to lower input costs and savings from the restructuring.
Giving The Portfolio A Charge
Over the last year, we've noticed Grandma's condition slowly evolving for the worse. Because of this, we've decided to emphasize current income over dividend growth. With the steady march of stock prices higher for the last couple years, dividend yields have been decreasing. A good place to look for yields now, and still meet our guidelines outlined in our first article, was in utilities.
The Starting Lineup
Once again I turned to the latest version of David Fish's CCC list available here to compile a list of suitable candidates. The first thing I did was eliminate everything but utilities; gas and electric.
Next, I sorted by yield, column I, and removed everything below 3.5% and above 7%. The spreadsheet was almost a month old at the time so I needed to provide some leeway as I narrowed the list down. I was left with a list too big to examine everything so I continued to narrow down my selection list further.
Utilities are not so straightforward when trying to select an appropriate investment. Like telecoms, the business requires large capital investment not only for new construction but also for maintenance of their plants and equipment and recovering from major storm damage. Additionally, utilities are regulated by their respective state public utility commissions where they do business and by the Federal Energy Regulatory Commission (FERC). These commissions generally can set rates of return, mandate certain operating procedures, siting of large transmission lines and, in the case of generating utilities, siting of generation stations and influence the choice of fuel used in generation. As a result, public utilities do not have the flexibility in their operations of a non-regulated company.
Most of the remaining companies had high payout ratios, which I expected, yet most also had 'n/a' in the FCF payout ratio column. I needed to look for something more helpful in making my decision and take a look at payout ratios later. I scanned across the spreadsheet looking for an appropriate statistic to eliminate some of the choices. I decided to use the 'Chowder Rule' (column BX). The Chowder Rule was developed by Seeking Alpha contributor Chowder to rank stocks and is the sum of the current yield and 5 year dividend growth rate. For utilities, Chowder requires a minimum result of 8 due to the nature of the business. I eliminated those with a Chowder Rule value less than 8. This left me with 10 companies to continue my comparison. Price and dividend amounts were taken from Yahoo! Finance on November 22nd, 2013.
Alliant Energy Corp (LNT)
Avista Corp (AVA)
CMS Energy (CMS)
Dominion Resources (D)
New Jersey Resources (NJR)
Northeast Utilities (NU)
PPL Corp (PPL)
Southern Co (SO)
Westar Energy (WR)
Wisconsin Energy (WEC)
Obviously, I needed something to further pare the list. Since the emphasis is on current yield, I eliminated everything below 3.5% dividend yield. You'll note that some are below the 3.5% cutoff used with the CCC spreadsheet. This is due to the price appreciation since the latest version was published, 10/31/2013, and points to the reason for not using strict criteria when screening for stocks.
While reviewing the financial data for each of these companies, I further eliminated CMS Energy due to 4 years of negative earnings in the first half of the '00 decade. This left us with a manageable list to research further.
I reviewed the S&P Capital IQ stock summaries, their web sites and annual reports to get a little better understanding of each company. Rather than an in-depth description, I've summarized the finalists below.
Alliant Energy is a utility holding company providing gas and electric service to retail and wholesale customers in Iowa, southern Minnesota and southern Wisconsin through its subsidiaries, Interstate Power & Light and Wisconsin Power & Light. Both subsidiaries generates electricity as well as purchase power on the wholesale market. LNT has a fuel mix of approximately 49% coal, 37% natural gas and the balance made up of oil, wind, hydro and purchased power.
Avista Corporation is an energy company involved in the production and distribution of electricity and natural gas in eastern Washington, northern Idaho and parts of southern and eastern Oregon. Ecova, an unregulated subsidiary, provides energy management solutions for Fortune 1000 companies. The majority of electricity generated is hydroelectric along with geothermal and purchases of power from outside sources.
PPL Corporation is an energy and utility holding company with four major subsidiaries: PPL Electric supplying electricity to eastern and central Pennsylvania, Kentucky regulated which supplies gas & electric service through Louisville Gas & Electric and Kentucky Utilities, a UK regulated electric utility supplying southwest & central England and South Wales through Western Power Distribution Co. and a power supply division generating 11,000 MW of merchant power in Pennsylvania and Wyoming.
Southern Company is an energy holding company serving a large swath of the southeastern U.S. with a variety of subsidiaries; Alabama Power, Georgia Power, Gulf Power and Mississippi Power all supplying electricity through their territories, Southern Power division that generates & transmits wholesale power to numerous entities across the southern U.S., Southern Generation performs generating and distributing power throughout its territories, Southern Telecom providing fiber optic communications in the southeast and SouthernLINC Wireless providing cellular service in selected markets across the U.S.
Wisconsin Energy provides natural gas and electric service to areas of Wisconsin and Michigan's upper peninsula. It includes 2 regulated utilities, Wisconsin Electric Power and Wisconsin Gas LLC. Other subsidiaries include W.E. Power, LLC which designs, builds and operates electric generating stations, and WISPARK, LLC, a real estate developer.
As can be seen, the utility segment is highly diverse and complicated. It was difficult compiling consistent business model descriptions to compare so I will rely mostly on financial indicators to help narrow the choices.
10Y Avg P/E
Est 5Y EPS Growth
Last 5Y EPS CAGR
Last 4Q EPS
EPS Payout Ratio
Alliant Energy Corp
(1) Nine year average P/E due to extraordinary events in 2005 skewing P/E
As can be seen, results can be highly variable. For example, SO's payout ratio is high because of one bad quarterly result. This was due to extraordinary charges against earnings from construction cost estimates and lease restructurings. Removing the extraordinary charges produced a P/E for SO of 18.3 and a payout ratio of 90%. If you look closer, all their earnings history have been fluctuating over the last 5 years for many reasons.
Show Us The Money
Since reported results can be so variable and all the dividends look safe, I decided to use the analysts estimates of forward 5 year EPS growth to estimate dividend growth. Since dividends come from earnings, this seemed like a reasonable assumption for dividend growth.
Est 5Y EPS
Total 5Y Income
Alliant Energy Corp
The results for PPL and SO were very similar and were my finalists. I again reviewed the latest annual reports and analysts' comments.
I decided on SO for several reasons. Southern Company is in a supportive regulatory region, has several diverse businesses in both the regulated and unregulated energy markets and has had fairly consistent performance. Although the P/E is a little higher than I would like, the income meets our goals and population trends are in their favor.
I hope this gives those of you looking for current income some ideas to investigate further. Our focus is on current income over the next few years. Be aware that rising interest rates can not only affect stock prices of utilities in the short term, it can also impact their earnings prospects in the future. Should the Fed begin to taper the QE program, we may be looking to reduce our position until interest rates stabilize.
In the meantime, we've placed our limit order slightly below the current price and wait for a little price weakness.
Additional disclosure: A limit order has been placed for SO and may have executed by the time this is published.