Electric utility companies in the U.S. are working to increase their regulated operations and decrease exposure to competitive operations as forward power prices remain weak. PPL Corp. (NYSE:PPL) is among the leading utility companies in the U.S. who intend to increase regulated operations and lower earnings volatility attached to competitive operations. Also, the company has diverse geographical operations, with operations in the U.K. and the U.S. I am bullish on the stock and advise dividend-seeking investors to buy the stock as it offers a high dividend yield of 5%, trades at an attractive forward P/E of 13.6x, offers potential price appreciation of 10% (based on my price target of $33), has increasing exposure to regulated operations and offers solid forecasted rate base growth of 8% over the coming years.
Diversified electric utilities, including PPL, are focusing less on competitive operations and more on regulated operations. The company has been investing to increase its regulated operations, as the health of its competitive business operations remain weak due to weak power prices. Also, investment in regulated operations will give a result in earnings growth in the coming years, as investment will be recovered from rate base increases; the company is anticipating a regulated rate base growth of 8% in the coming four years. The following table shows the growth in the regulatory asset base.
Source: Company Presentation
As market conditions of competitive operations remain weak, PPL has the option to sell its competitive power assets and exist within the competitive power market; the company currently has approximately 10GW of competitive power capacity. The sale and exit from the competitive market will further lower PPL risks and positively impact price multiples. However, I believe the company will wait for an improvement in upcoming PJM auction prices in May, before deciding to sell off its competitive assets, as currently the valuations remain depressed. Also, PPL might opt for a merger with smaller competitive power producers and benefit from synergies.
Also, the company has been making efforts to diversify its generational fleet, away from coal generation fleet, and improve its risk profile. Earlier, the company sold its non-core hydro assets and invested in natural gas and solar power fleet. Last week, the company requested an approval for a 700MW natural gas plant with Kentucky regulators. The efforts to diverse generational fleet will portend well for the company's risk profile and financial performance in future. Also, the company is monitoring the development in the solar power market and might announce to ramp up its solar power operations. Other companies within the industry, including Dominion Resource (NYSE:D), Duke Energy (NYSE:DUK) and Southern Company (NYSE:SO), also showed the intention in the recent EEI Conference to adapt to growing solar power rather than opposing it. As investment prospects remain attractive for PPL in the near term, it will allow for rate base and earnings growth for the company.
Stock Price Catalysts
The final outcome of the U.K.'s 'Fast Track' process in the U.K. is expected next month, in February, as Ofgem will make a final determination in the proceedings. The outcome of the fast track request is expected to be constructive given the preliminary positive decision in November. Approval of the fast track request will allow for additional annual revenues of $35 million, 8 years of rate clarity and higher level of cost retention.
In the upcoming quarters, the company could opt to sell competitive assets or merge with smaller competitive power producers, if the power markets remain weak. This will allow PPL to unlock the value of its competitive power assets, which will portend well for consolidated earnings and the stock price. The company has yet to decide the fate of its competitive power assets, which I believe depends on the upcoming PJM auction prices in May.
The company has a solid dividend profile, as it has been consistently increasing dividends in recent years; in the last five years it has increased dividends by approximately 3.5%. Currently, the stock offers a high dividend yield of 5%, making it an attractive stock for investors' income portfolios. It has a dividend payout ratio of approximately 60%, consistent with its long term target payout ratio of 60%-70%. I believe the company will announce a dividend increase in the ongoing year, consistent with its earnings growth and by increasing its dividend payout ratio to mid-range of the targeted payout ratio of 60%-70%. The following table shows the payout ratios, dividend coverage and annual dividends for PPL.
Source: Company Reports and Calculations
(Note: Dividend Coverage ratio = OCF/Annual Dividend).
PPL's margins and sales are sensitive to commodity prices and forward power prices. A decrease in commodity prices could adversely affect the financial performance and price multiples of the company. Also, like other dividend paying utilities, rising bonds yields could put pressure on multiples and the stock price of PPL.
I am bullish on PPL due to its increasing regulated operation exposure, rate base growth, and attractive dividend yield of 5%. Also, the stock is trading at an attractive forward P/E of 13.6x in comparison to the utility sector's forward P/E of 15.2x. The stock offers a potential total return of 15%, including potential price appreciation of 10% and a high dividend yield of 5%. I calculated a price of $33 for PPL, using the estimated EPS of $2.17 for 2014 and utility sector forward P/E of 15.2x.
2014 EPS est.
Utility Sector Forward P/E