Black Hills: Does The Risk Justify The Reward?

| About: Black Hills (BKH)

A Dividend Champion is defined as a company that has increased its dividend every year for 25 or more straight years. Black Hills Corp. (NYSE:BKH) is a dividend champion that has raised its dividend every year for 42 consecutive years. The complete Dividend Champions list is compiled courtesy of David Fish. (Open as an excel spreadsheet and look at the tabs on the bottom to find the Dividend Champions list).

About Black Hills Corp. (from their website):

Black Hills Energy-Colorado Gas serves 70,000 natural gas customers in 31 Colorado communities. Black Hills Energy is a subsidiary of Black Hills Corp. - a diversified energy company with a tradition of exemplary service and a vision to be the energy partner of choice - based in Rapid City, S.D., with corporate offices in Denver and Papillion, Neb. Black Hills Corp. serves 762,000 natural gas and electric utility customers in Colorado, Iowa, Kansas, Montana, Nebraska, South Dakota and Wyoming, and its non-regulated businesses generate wholesale electricity, produce natural gas, oil and coal, and market energy. Black Hills' 2,100 employees partner to produce results that improve life with energy.

Black Hills Corp.: A Dividend Champion with 42 Consecutive Years of Dividend Increases

Since dividends are paid out of earnings, a clear perspective of a company's historical earnings growth record is a vital component of a dividend investor's prudent due diligence process. The following graph plots Black Hills Corp.'s earnings per share since 1998. A quick glance to the right of the graph shows that Black Hills Corp. has increased earnings at a compounded rate of 2.5% (see purple circle on graph) per annum.

However, the reader should note the cyclical nature of the company's earnings history. Therefore, even though this company has increased their dividend every year for 42 consecutive years, when you review the performance table below, you will note that many of the dividend increases have been rather small, at around 3% per annum. The moral of the story is that not all Dividend Champions are the same. Some grow faster than others, and some are more consistent than others. Consequently, having a clear perspective of the company's operating history provides the prospective investor the necessary information to make a sound and rational decision.

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Dividend Champions Gave Shareholders a Raise in Income 25 Years Straight or Longer

With interest rates hovering near all-time lows, investors seeking income are faced with very limited choices. The traditional high yield available from bonds and other fixed income vehicles are no longer available to meet the goals of retirees needing income to live off of. Moreover, it is almost a certainty that today's low yields are not adequate enough to fight inflation. Consequently, there is a growing investor interest in dividend paying common stocks, especially those that have a long record of increasing their dividends every year.

Earnings Determine Market Price and Dividend Income: The following earnings and price correlated F.A.S.T. Graphs™ clearly illustrates the importance of earnings to both price movement and dividend income. The earnings growth rate line or True Worth ™ line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.

Here is a link to a live and fully functioning graph on Black Hills Corp. We suggest running graphs over numerous time frames as part of a more comprehensive fundamental analysis. This will provide the reader the opportunity to review a more thorough fundamental analysis of the company.

Since dividends are paid out of earnings, and therefore represent additional return on top of what the market capitalizes earnings at, they are depicted by the light blue shaded area and stacked on top of the earnings line. Therefore, a quick visual of these two important components is simultaneously revealed: The additional return that dividend paying stocks provide, plus the percentage of earnings paid to shareholders as dividends (payout ratio).

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Performance Table: Capital Appreciation and Dividend Income

The associated performance results with the earnings and price correlated graph, validates the above discussion regarding the two components of total return: Capital appreciation and dividend income. Dividends are included in the total return calculation and are assumed paid, but not reinvested.

When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 2.6% capital appreciation (Closing Annualized ROR), long-term shareholders of Black Hills Corp. would have received an additional $74,590.15 in dividends that increased their total return from 2.6%% to 5.6% per annum.

(Note: Since this is a Dividend Champion, it has raised its dividend every year for at least 25 years, therefore, negative dividend growth rates shown, if any, will be attributed to special additional dividends paid in excess of the company's regularly reported dividend rate.)

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The following graph plots the historically normal PE ratio (the dark blue line) correlated with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as normal as it has been since 1998.

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A further indication of valuation can be seen by examining a company's current price to sales ratio relative to its historical price to sales ratio. The current price to sales ratio for Black Hills Corp. is 1.16, which is historically normal.

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Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns, and the dividend and its growth rate are a function of two critical determinants:

1. The rate of change (growth rate) of the company's earnings

2. The price or valuation you pay to buy those earnings

Therefore, forecasting future earnings growth, bought at sound valuations, is the key to safe, sound, and profitable performance.

Therefore, it logically follows that measuring performance without simultaneously measuring valuation is a job half done. At its current price, which is attractively aligned with its True Worth™ valuation, Black Hills Corp. represents a potential opportunity to invest in a Dividend Champion at a reasonable price. The important factor is that Black Hills Corp. has real assets and cash flow underpinning its stock price. This solid economic foundation offers shareholders the potential for both a strong margin of safety and an opportunity for an increasing dividend income stream and potentially attractive future returns.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

The consensus of 6 leading analysts reporting to Capital IQ forecast Black Hills Corp.'s long-term earnings growth at 5%. Black Hills Corp. has high long-term debt at 56% of capital. Black Hills Corp. is currently trading at a P/E of 27.5, which is outside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Black Hills Corp.'s True Worth valuation would be $41.57 at the end of 2017, which would be a 7.6% annual rate of return from the current price, including assumed dividends.

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Earnings Yield Estimates

Discounted Future Cash Flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because Earnings Determine Market Price and dividend income in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in Black Hills Corp. to an equal investment in 10-year Treasury bonds illustrates that Black Hills Corp.'s expected earnings would be 4.1 times that of the 10-Year T-Bond Interest. (See EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.

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Summary and Conclusions

This report presents essential "fundamentals at a glance" on Dividend Champion Black Hills Corp., illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although with just a quick glance you can know a lot about the company, it's imperative that the reader conduct his or her own due diligence in order to validate whether the consensus estimates seem reasonable or not.

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

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.