Caribbean Utilities (OTC:CUPUF) is not exactly a household name in the investment world. In fact, there are only 2 readers receiving alerts for this security on Seeking Alpha, and I am not one of them! To provide a data-point for comparison, 15,898 people get AT&T (NYSE:T) articles and Market Currents by email alert from SA. Now, why would I write this article if there is such a small target audience? The answer is that this is a stock worth considering - if your goals are high-yield and moderate risk.
Caribbean Utilities is a micro-cap utility, with generally-low volatility and a 7% yield. It trades and pays its dividends in USD (even on the Toronto Stock Exchange). With a market capitalization of $275M, it is traded over the counter - OTC - under the symbol CUPUF in New York, and with much higher volumes on the Toronto Stock Exchange (TSX:CUP.U). There are few analysts currently following this security - micro-caps rarely attract security analysts' attention - which may leave this security undervalued. Additionally, institutional investors cannot build material positions without owning a significant stake in the company, which discourages their research and analysis. One analyst, as reported by Yahoo Finance, rated it as an "Underperform". There are reports available (for a fee) at the Financial Times. Therefore, there is some informative material available, but unlike the mega-caps it is largely up to you to develop your own conclusion on whether to invest. To simplify your research, you can review all of the Caribbean Utilities corporate filings on Sedar.
After identifying this investment candidate, my first step was to determine if the Cayman Islands is a good place to invest. The short answer is "yes" and here is why: The Cayman Islands is a British Overseas Territory located in the western Caribbean Sea. They have more registered businesses than they have people (2010 census the estimated resident population is 54,878 people)! With an average income of around USD $60k, Caymanians have the highest standard of living in the Caribbean, and their GDP per capita is the 14th highest in the world. The government's primary source of income is indirect taxation: There is no income tax, capital gains tax, or corporation tax. There is import duty of 5% to 22% and last year they introduced a payroll tax to be paid by expatriate workers. The Cayman Islands are the fifth-largest banking centre in the world, with $1.5 trillion in banking liabilities; 260 of the 279 banks are licensed to operate on an international basis with only limited domestic activity.
Caribbean Utilities Company, Ltd. (CUC) operates the only electrical utility in Grand Cayman. It commenced operations in 1966 and is engaged in the generation, transmission and distribution of electricity.
It has a 20-year transmission and distribution license (which expires in April 2028) and a 21.5-year generation license (which expires in September 2029) with the Cayman Islands government. It has an installed capacity of 152.6 megawatts, seven transformer substations, approximately 345 miles of land-based high-voltage transmission and distribution lines, and 15 miles of high-voltage submarine cable. The Company uses diesel generation to produce electricity for Grand Cayman.
This opportunity is for investors is to participate in a regulated monopoly. There are enormous, natural barriers to entry. The higher the barriers to entry and exit, the more prone a market tends to be a natural monopoly. The Cayman Islands are located in the middle of the Caribbean Sea and there is no obvious alternative power source.
Warren Buffett's comments about "economic moats" aptly summarizes CUC's protected business:
According to Buffett, the wider a business' moat, the more likely it is to stand the test of time. In days of old, a castle was protected by the moat that circled it. The wider the moat, the more easily a castle could be defended, as a wide moat made it very difficult for enemies to approach. A narrow moat did not offer much protection and allowed enemies easy access to the castle. To Buffett, the castle is the business and the moat is the competitive advantage the company has. He wants his managers to continually increase the size of the moats around their castles.
Forget Buffett's moat - how wide can a moat become in any event? CUC's power generation and distribution business is protected by an "economic Caribbean Sea". Courtesy of Google Maps, one can see that the nearest competition would be hundreds of miles away - a long distance to lay undersea power cables to small power market (click to enlarge images):
Let's first examine industry and the company risks. The industry aspect is fairly obvious. CUC is the only electric utility on a relatively isolated island group. Other than drinking water, food, and shelter, it is the next basic requirement for modern living. I cannot imagine the 55,000 inhabitants voluntarily going back to a pre-electric lifestyle. Therefore, it is a great industry - particularly in this geography, where it has no competition. The benefit or disadvantage of regulation is open for interpretation and debate. There detractors would propose that the company activities and resources can be diverted to societal goals (as the government of Brazil recently mandated a reduction of electricity costs to power consumers), whereas the positive view is that the government would seek to provide a reasonable return to shareholders for economically valuable services. Based upon my review of the history, with a few exceptions, the Cayman Islands government and CUC seem to be effectively managing this balance.
Many investors correlate market capitalization to risk - in fact, Ken Fisher writes about mega-cap stocks and returns for Forbes (one example is here). Based on the "too big to fail" (TBTF) criterion, it is clear that the risk and return of this (and other) micro-caps can be concern for investors. I agree that TBTF does tend to provide a floor to share price, but Hewlett Packard (NYSE:HPQ), Research In Motion (RIMM), Nortel, and others prove that size alone is not an adequate defense. I suggest that CUC may be a special case; although a small cap, it does not appear to be any riskier than larger-capitalization companies. I would characterize this as "moderate risk", based on the financial information and market position. I have assembled some metrics (with my comments), and created a few graphs in order to help you reach your own risk/return conclusions:
Recent Share Price
Bottom 1/2 of trading range
52 Week Range
10.51 - 9.00
$2 upside for each $1 downside @ $9.43
Stable - see below
55% debt : 45% equity
Per their target; maintain investment grade
Operating Margin = 10.5%
Staid, reasonable performance
As a regulated utility, it is practically legislated to stay in business. On the other hand, there is little room for growth, given its market and services. In other words, it is almost like a long-term bond - enjoy your 7% yield, but expect limited capital and dividend growth.
I have extracted some financials, which indicate a steady hand managing the business:
Basic Normalized EPS
Total Current Assets
Total Cash from Operations
Total Cash from Investing
Total Cash From Financing
Net Change in Cash
Let's take a look at the numbers over the last 4 years. Just a quick glance at these graphs indicate that CUC is a "steady eddy" investment.
Starting with the Income Statement, there is slowly growing revenue with flat Normalized EPS:
The second quarter results for the period ended June 30th, 2012 were less than stellar:
Net earnings for the three months ended June 30, 2012 ("Second Quarter 2012") were $5.1 million, a decrease of $0.8 million, or 14%, when compared to $5.9 million for the three months ended June 30, 2011 ("Second Quarter 2011"). A 3% decline in kilowatt hour ("kWh") sales and higher depreciation costs and finance charges were partially offset by decreased general and administration, consumer service and maintenance costs for the Second Quarter 2012 when compared to the Second Quarter 2011.
I view this as a pull-back buying opportunity - after all, my goal is yield-on-investment, and the same press release indicates the steady client base and market:
As at June 30, 2012, the total number of customers on record at the company was 26,830, an increase of 443 customers, or 2%, compared to 26,387 customers as at June 30, 2011. The Company had a net increase of 75 customers for the Second Quarter 2012, comprising 39 residential connections and 36 commercial connections.
CUC has a fairly static balance sheet, assets, and liabilities:
Clearly, this is not a rapidly expanding or contracting balance sheet. CUC targets a long-term capital structure containing approximately 45% equity, including preference shares and 55% debt (and was on target in Q4/2011). The company's objective is to maintain investment-grade credit ratings.
CUC cash-flow is expectedly steady lines, with two exceptions:
The two anomalies are "cash from financing" and "cash from investing" in 2010 - otherwise, these would also likely be flat lines. I examined their Q3 2010 results, which state that:
This decrease (authors note: in Cash From Financing) is attributable to decreased capital related expenditures... This change in cash received is mainly attributable to the funding received from debt financing in 2009.
One of my investment concerns is always the credibility of financial and non-financial information, and the capability and honesty of management. For my portfolio, this concern has precluded most investments in developing countries. The good news is that this is not a developing country and their website attests to the high quality of their corporate governance. A form of governance "insurance" is that a major shareholder - with 59% of the common shares - is Fortis (OTCPK:FRTSF), which has a $6.5B market cap and is traded on the TSX [TSX:FTS]. Fortis is the largest investor-owned distribution utility in Canada (serving more than 2,000,000 gas and electricity customers. As a substantial shareholder, Fortis would have a vested interest in accurate reporting and provide an additional layer of oversight. A last point on this subject is that a report published by the International Monetary Fund, in March 2005, recognized the jurisdiction's comprehensive regulatory and compliance frameworks.
The following 1-year and 5-year charts are courtesy of CIBC Investors Edge for the Canadian-traded security [TSX:CUP.U], as the volumes for the OTC-traded CUPUF.PK are too low to provide contiguous trend-lines.
From the one-year chart, we see relatively static prices and low volumes. Except for the occasional spike (which may be a data issue?), the stock has been trading in a range for the past year:
The 5-year chart shows how the share price has not recovered from the financial melt-down; it had historically traded in the $10-$12 range. Part of the problem is that there was "bad news" (and financial results) in 2008, as described in their November 27, 2008 news release:
The 30 per cent decline in earnings per share for the six month period was due principally to the removal of the Hurricane Ivan Cost Recovery Surcharge and a 3.25 per cent rate reduction, both in January of 2008, partially offset by 4 per cent kiloWatt-hour ("kWh") sales growth.
Hurricanes are infrequent but are still one of the major risks for CUC. Reconstruction and lost revenues (and in this case, a subsequent year's reduction of surcharge) from these catastrophes impacts their financials for years. The electrical system and service on the island may be damaged. The hurricanes plus high precipitation in certain years has exacerbated the subsequent market melt-down and has created a slow and long share price recovery.
This does not look like a chart of a stock to actively trade for capital gains. Although I prefer to buy securities which trade 20%+ below their annual highs, CUC does not seem to have sufficient volatility to enable this. That said, it continues to trade well-below the crash high. Overall, my interpretation of the trend is that this stock is a buy-and-hold. Investors can also enjoy the 7% yield (which is exceptionally high, given that the current, US quantitative easing will keep yields very low for many years).
As a last item, let's examine the dividend history. Vuru has an excellent graph and table which summarizes this history:
I added year-end stock prices for 2004 to 2008 in order to produce the following graph of the dividend-per-share and dividend yield:
This chart suggests that Caribbean Utilities is a relatively steady dividend-payer but not an appropriate target for dividend-growth investors. The dip in 2005 is because of a major hurricane in late 2004 (Hurricane Ivan), which substantially impacted the financials.
To wrap-up, if you tend to hold your investments for years, and if your goals are income-oriented, high-yield, geographic diversification, and moderate risk, then Caribbean Utilities may provide an appropriate (small) holding for your portfolio. As you can see from the disclosure, I (recently) decided that it has a place in mine.