Entergy Corporation (ETR) engages in electric power production and retail distribution throughout the southeast of America. Their comparable valuation metrics are currently below most of their utility peers, which makes the stock appear cheap on a relative basis. Additionally, ETR has traded within a predictable upper and lower range since the beginning of 2009 and has established a lower support level at $59.57 (10.7% below 10-Oct-11 close of $66.71). Therefore, the downside risk appears to be minimized if purchased at its current level. As outlined below, I discuss the rationale for going long this stock as well as the risks involved.
High dividend yield among peers – Entergy’s dividend yield (4.98%) is the second highest among its peers (as of 10-Oct-11). Per historical practice (since 1988), Entergy has regularly paid quarterly dividends. The lowest annualized yield for a quarterly dividend has been 1.8%, which occurred on 8-May-07. Since 1999, Entergy has increased dividends every 2-3 years and the last increase was effective for dividends paid on 10-May-10.
Attractive valuation against peers – Entergy’s P / EPS (estimate current year) and P / EPS (estimate next year) ranks in the bottom 5% among their peers, which suggests Entergy is currently undervalued on a relative basis. On an absolute basis Entergy is trading at 1.37x its book value and 1.05x revenue.
The following table displays valuation metrics (based on 10/10/11 closing price) ranking Entergy against their peers:
Established trading range – Entergy is currently trading near the low-end of its trading range. Entergy’s current lower support level ($59.57) was established on 8-Aug-11. Entergy’s dividend appears to form a lower support level when the dividend yield rises above 5.0%. During the March 2009 lows, Entergy fell to $61.21 on 9-Mar-09, which was supported by a 4.9% annual dividend yield. Given that Entergy’s current dividend yield is ~5.0%, it presents a great buying opportunity as Entergy’s dividend yield is likely to fall (and price rise) once investors become less risk averse.
The following chart illustrates Entergy's trading range and support levels since 2009:
Declining profit margins in Entergy Wholesale Commodities business – Entergy Wholesale Commodities, Entergy’s nuclear energy production business, has experienced downward pressure on contracted pricing rates since 2008. For 2010, average realized revenue per MWh was $59.16 vs. 2011 average contracted price of $54. In addition, Entergy has contracted 87% of energy output for 2012 at $49 per MWh.
The following table shows Entergy Wholesale Commodities has maintained a relatively stable percentage of Entergy’s total revenue but a declining share of net income since 2008:
Although the Entergy Wholesales Commodities business is likely to continue to decline in profitability through 2012, Entergy’s Utility business currently produces the majority of net income. Therefore, declining contract prices should have a weaker effect on Entergy’s 2011 and 2012 overall business results.
Weak analyst estimates – Due to the weak contracted pricing in Entergy Wholesale Commodities, analysts have forecasted no growth in EPS from 2010 to 2011 ($6.66 actual vs. $6.66 estimate). Additionally, analyst estimates are currently forecasting EPS to decline 9.2% in 2012 from 2011 estimates ($6.05 vs. $6.66).
Although I believe these analyst estimates are accurate, the current $3.32 annual dividend is still far enough below forecasted earnings to not cause concern that management may lower the dividend.
Data are taken from Yahoo! Finance and Entergy’s publicly filed 10-Ks and 10-Qs