El Paso Electric (EE) is a small-cap electric utility servicing 377,000 retail customers in El Paso, TX and Las Cruces, NM. The breakdown of fuel used in power generation is nuclear 45% (co-owned with PNW), natural gas 22%, coal 7%, and purchased 27%. Peak production capacity is 1,650MW. EEE owns a large interest in the Palo Verde nuke plant and just received a 20-yr extension of its operating license until 2030. After a 19-yr hiatus, EE recently reinstated their dividend at an annual rate of $0.88/share.
Customer growth over the past 5-yrs has average 2.27%, far exceeding the industry average of 0.92%. This growth is anticipated to be augmented by expansion at the Fort Bliss Military Complex. Staffs stationed at the base are anticipated to grow from 23,000 currently to 35,000 in 2013, along with an additional 48,000 family members. It is anticipated that 8,000 new apartments will be needed to accommodate the influx. Currently, the military facility represents approx 60MW of annual electricity demand and it is expected to increase to 90MW when the expansion is completed.
Retail and small commercial clients comprise 65% of KWh revenues, with large commercial clients representing 14% and sales to public entities, such as the municipalities, state, and military, 21%. Retail, small commercial and public entities are usually characterized as more stable clients in a downturn. As the current economy continues to pick up steam in the West Texas, Southeastern New Mexico region, the large commercial sector should regain in usage.
Mr. Mario Gabelli, CEO of money manager and fund manager GAMCO Investors (GBL), was interviewed recently for the Barron’s Roundtable. His comments on El Paso Electric:
There are three traditional categories of utilities: electric, gas and water companies. The electrics are yielding about 4.5%. They have a 65% payout ratio, which isn't high, and earnings are growing 4% to 5% a year. There have been a lot of deals in the industry. El Paso Electric [EE] is a proxy for the group. The stock is 30 and there are 42 million shares. They will earn about $2.25 a share this year, growing by 5.5% to 6%. They are using cash flow to buy back stock and have reduced their shares outstanding in the past 10 years to 42 million. This is a great area. Fort Bliss, a military base in El Paso, is growing. It pays 88 cents a share and yields 2.9%. They just restored the payout, much to my objection. I would rather have them buy back stock so my clients can own more of the company. In El Paso's part of the world, there are three or four other utilities, all of which will figure out how to get some synergies by merging. The two logical parties are Public Service of New Mexico and El Paso Electric. One and one here equals two-and-half or three.
The dividend calculates to a payout ratio of just 40%, versus an industry average of 65%, leaving plenty of room for dividend expansion. Estimates are for a 7% distribution growth rate. However, it has a low current yield of 2.9%. Earnings are estimated to grow to the $2.50+ range next year and to $2.65 in 2013.
The company is waiting on regulatory permits to build an 87MW peak load generator at one of its facilities and is anticipating a new 288MW generation facility to be completed by 2015. These projects will increase peak capacity by about 22%. There are no pending rate cases for the balance of 2011, and cost control, along with an increase in demand, becomes critical to driving profitability. 2011 Cash flow is sufficient to fund cap ex, dividends and share buyback, with cap ex anticipated being a flat $200 million a year until 2014.
The company has been buying back shares at an average of 3.8% annually since 1999. The company continues to buy back shares, but the pace may slow as dividends are raised and capital expansion plans increase.
One current situation that should be monitored is the wildfires in Arizona and New Mexico, and their potential impact on Tucson Electric’s Springhill generating facility. El Paso is a purchaser of this power, and any interruption in either generating or transmission of power from that plant will adversely affect EE in the short-term.
The latest investor presentation dated March is here (pdf file).
Currently trading at a PE of 13.5 based on 2011 EPS, share prices could be considered fully valued. However, applying the same PE to 2013 earnings estimates, share prices could climb by 10% a year. Add this to EE’s growing distribution, and total stock returns could be in the 14% range.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.