PG&E Corp. (PCG) is a regulated natural gas and electricity utility operating in central and northern California that operates primarily through Pacific Gas and Electric Company, which is a regulated utility. Approximately 22% of its revenue is from gas and the other 78% from electricity sales based on the results from Q2 2011. PCG had about $13.8 billion in revenue in 2010. PCG has a market capitalization of $16.4 billion and an enterprise value of $29.7 billion, suggesting significant leverage. PCG has an inconsistent track record on dividends. From 2000 through the end of 2004, PCG did not pay any dividends. Furthermore, PCG is currently in a period of no dividend growth.
PCG's estimated forward dividend yield is 4.5% based upon a closing price of $41.09 and the author's projected annual dividend of $1.86. The following table shows the estimated forward quarterly dividends as well as the recent historical quarterly dividends.
Historical and Projected Dividends
|Type||Ex-Dividend Date||Quarterly Dividend ($ per share)||Change on prior year|
The above table shows that dividend growth was halted in 2011. I assumed that it would resume again at a lower pace in 2 quarters based on the following analysis. Based on the notion of strong net income growth, one should reasonably expect another dividend increase in the near future. Even while the payout ratio is projected to be relatively high for Q4 2011, it is currently and for Q3 2011 projected to be below the recent historical average of about 55%.
Dividends, Payout Ratio and Net Income
Source: SEC filings, Yahoo!Finance for analyst per share estimates for next two quarters to estimate projected quarterly net income available to common, author calculations.
The following graph shows the historical trailing twelve month yield and spread to the 10-year Treasury bond.
Created from data from Yahoo!Finance
The next graph shows the normalized performance of the stock price, the dividend, and the trailing dividend yield.
Created from data from Yahoo!Finance
The above chart shows that PCG has not kept pace with its dividend increases, suggesting that its future growth opportunities are declining relative to earlier periods. This graph also shows that PCG has gone through periods without dividend growth. This should require a discount for future long term growth.
The first step to using the dividend discount model is to calculate an equity hurdle rate with the Capital Asset Pricing Model. PCG has a beta of .22 and with the risk free rate at a very low 2.2% this gives the discount rate to be a 3.7%. As noted above the forward dividend is approximately $1.86. Applying a long term growth rate of 1% gives an estimated price of $68.18 for PCG, which is about 66% above the current price. The critical concern about future growth for dividends is not whether the forward annualized dividend is slightly higher or lower, but rather if the assumed long term growth rate is justified.
Running DDM in reverse and solving for the growth rate would give a growth rate of -.8%, which might be a little more consistent with PCG stock price declining relative to dividends shown in the previous graph. However, as with any dividend discount model, the price is highly sensitive to growth rate and hurdle rate assumptions.
Sensitivity Hurdle Rate Growth Rate 3.7% 4.7% 5.7% 6.7% -2.0% 32.47 27.65 24.07 21.31 -1.0% 39.34 32.47 27.65 24.07 1.0% 68.18 49.89 39.34 32.47 2.0% 107.64 68.18 49.89 39.34 3.0% 255.49 107.64 68.18 49.89 4.0% NA 255.49 107.64 68.18
Looking at the sensitivities, the change from 2% growth to 1% growth results in the loss of approximately 37% of the value of the stock. However, changing the forward annual dividend from $1.86 to $1.82 for no near term growth, would revalue the stock at just $66.72 relative to $68.18 in the base case, a reduction of just 2%.
PCG appears to have a reasonable valuation with an attractive dividend yield of 4.5% on a forward basis or 4.4% on a trailing twelve months basis. If one believes that dividend growth will resume in a consistent way over the long term, then PCG is probably undervalued, even with an increasing interest rate environment.
Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.