Ameren Increases Its Dividend: Stock Looks Slightly Undervalued

 |  About: Ameren Corporation (AEE)
by: Bennington Investment Ideas

Ameren Corp. (NYSE:AEE) recently announced an increase to its quarterly dividend to $0.40 per share per quarter resulting in a 2.6% increase in its stock price, which closed at $30.70 on October 14th. AEE is a regulated gas utility operating in Missouri and Illinois. It provides transmission and distribution services for natural gas. It also operates as an electric utility with generation, transmission and distribution services.

AEE had about $7.6 billion in revenue in 2010. AEE has a market capitalization of $7.4 billion and an enterprise value of $14.6 billion, suggesting significant leverage. AEE has a strong track record of paying dividends. AEE's estimated forward dividend yield is 5.2% based upon a closing price of $30.70 and the author's projected annual dividend of $1.60. 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
Projected 9/6/2012 0.4000 3.9%
Projected 6/6/2012 0.4000 3.9%
Projected 3/7/2012 0.4000 3.9%
Projected 12/6/2011 0.4000 3.9%
Historical 9/6/2011 0.3850 0.0%
Historical 6/6/2011 0.3850 0.0%
Historical 3/7/2011 0.3850 0.0%
Historical 12/6/2010 0.3850 0.0%
Historical 9/7/2010 0.3850 0.0%
Historical 6/7/2010 0.3850 0.0%
Historical 3/8/2010 0.3850 0.0%
Historical 12/7/2009 0.3850 -39.4%
Historical 9/8/2009 0.3850 -39.4%
Historical 6/8/2009 0.3850 -39.4%
Historical 3/9/2009 0.3850 -39.4%
Historical 12/8/2008 0.6350 0.0%
Historical 9/8/2008 0.6350 0.0%
Historical 6/9/2008 0.6350 0.0%
Historical 3/3/2008 0.6350 0.0%
Click to enlarge

Source: Author estimates, Yahoo Finance

The following graph shows the historical trailing twelve month yield and spread to the 10-year Treasury bond.

Created from data from Yahoo Finance

Like many dividend stocks, AEE showed a what appeared to be a spike in yield in the spring of 2009. The next graph shows the normalized performance of the stock price, the dividend, and the trailing dividend yield.

Created from data from Yahoo Finance

In February 2009, AEE announced a dividend reduction from $0.60 to $0.385 per share per quarter. The stock dropped approximately 17% on that news. Because these graphs use trailing twelve month dividends (you can see it clearly in the sloped green line showing each quarterly dividend of $0.60 being replaced by the lower $0.385) the graph shows a yield pop driven by the lower stock price and the still buoyed dividend.

The above chart also shows that AEE stock price has largely adjusted to the new dividend level and sustains a similar yield as it had prior to the reduction.

Dividend Discount Model Suggests Slight Undervaluation

The first step to using the dividend discount model is to calculate an equity hurdle rate with the Capital Asset Pricing Model. AEE has a beta of .53 and with the risk free rate at a very low 2.2% this gives the discount rate to be a 5.9%. As noted above the forward dividend is approximately $1.60. Applying a long term growth rate of 1% gives an estimated price of $32.39 for AEE. This is a slight premium to the recent closing price. However, as with any dividend discount model, the result is highly sensitive to growth rate and equity hurdle rate assumptions.

Dividend Discount Model Sensitivities

Sensitivity Equity Hurdle Rate
Growth Rate 4.9% 5.9% 6.9% 7.9%
-2.0% 23.05 20.15 17.90 16.10
-1.0% 26.94 23.05 20.15 17.90
0.0% 32.39 26.94 23.05 20.15
1.0% 40.61 32.39 26.94 23.05
2.0% 54.42 40.61 32.39 26.94
3.0% 82.47 54.42 40.61 32.39
Click to enlarge
Source: Author calculations

Estimating AEE's future dividend growth is a key consideration in looking at its value. The stock price increased $0.77 on the news. However, the following table shows the analysis of the impact of the dividend increase below:

Dividend Increase Impact

Metric New Old Change
Dividend ($) 1.60 1.54 0.06
Equity Hurdle Rate 5.9% 5.9% NA
Growth 1.0% 1.0% NA
Implied Value ($) 32.39 31.17 1.21
Click to enlarge

Source: Author calculations

Applying the DDM to both the before and after scenarios suggests that AEE should have had a larger price increase, assuming the same long term growth. Applying the dividend discount model suggests that the increase should have been over a dollar instead of just $0.77. However, there are a couple explanations: this increase might have been anticipated already and some portion of the increase was priced in by October 13th or that the stock is now slightly undervalued.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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. You can now follow me on twitter @jtcbp.