Given domestic volatility, some of the most attractive defensive plays can be found in utilities. CenterPoint Energy (CNP) and Dominion Resources (D) has prevailed through natural disasters and a stormy economy. Despite this, the firms have limited growth potential at the present moment, and will struggle to expand multiples. Since I first wrote a reserved article on CenterPoint, the stock has underperformed the S&P 500 by nearly 3 percentage points. While the industry is structurally stable as far as stock returns are concerned, the upside is limited.
From a multiples perspective, CenterPoint is the cheaper of the two, which is warranted since the utilities firm has bearish growth projections. It trades at a respective 10.6x and 15.8x past and forward earnings, while Dominion trades at a respective 19.4x and 15.5x past and forward earnings. Both firms offer dividend yields around the 4% territory and are strong in terms of capital allocation.
At the third quarter earnings call, Dominion's CEO, Tom Farrell, noted strong demand despite natural disasters:
Moving to operations, our generating plants performed well in the third quarter. Surry Units 1 and 2, Millstone 3 and Kewaunee achieved capacity factors greater than or equal to 98.7% during the quarter. Before the earthquake, North Anna Unit 1 had been online for 298 consecutive days, and Unit 2 for 289 consecutive days. Millstone Unit 3 had been online 409 days through the end of the third quarter. Millstone Unit 2 experienced a 14-day outage due to a leak in the service water piping…
We expect demand from data centers to grow from 295 megawatts at the end of 2010, to a total of 370 megawatts by the end of this year. Much of which has already been realized through the third quarter. Data center load is expected to grow approximately 545 megawatts by the end of next year, and to approximately 715 megawatts by the end of 2013.
With unemployment in Virginia at around 6.5%, well below the national average, the firm has a demand advantage. 3Q11 EPS was below 3Q10 largely due to Hurricane Irene and lower merchant generation, but still slightly higher than the consensus. In addition, shareholders benefited from strong buyback activity that drove ROE and was accretive to EPS. Notably, the outcome to the biennial rate review was in line with expectations: the firm will refund ratepayers $78.2M as a result of being above the authorized ROE band. Going forward, I anticipate strong performance in the regulated business, but struggling merchant generation as lower capacity and energy prices sync shift hedges. Management has lowered 2011 guidance to $3.05 - $3.25 for EPS.
Consensus estimates for Dominion's EPS are that it will decline by 6.3% to $3.13 and then grow by 4.5% and 7.3% in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $3.22, the rough intrinsic value of the stock is $51.52, implying that the company is fairly valued. If the multiple were to decline to 13x and 2012 EPS turns out to be just 4% below the consensus at $40.82, the stock would fall by 19.6%. Accordingly, I believe that more attractive risk/reward exists elsewhere, but disagree with the "sell" rating on the Street.
I am equally reserved on CenterPoint, while the Street rates shares a "buy." The company had strong third quarter performance from resolving long-standing issues related to the true-up proceeding and strong growth in Houston Electric, with 35,000 more customers for the year. Going forward, management will be investing more in system hardening and reliability. Nevertheless, September rate changes have challenged volumes. CenterPoint should expand into liquids-rich projects and acquire only regulated utilities, boosting its growth trajectory and multiple.
Consensus estimates for the firm's EPS are that it will grow by 17.5% to $1.14 and then by 6.1% and 7.4% more in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $1.20, the stock is fairly valued.