Seeking Alpha

Roger S. Conrad's  Instablog

Roger S. Conrad
Send Message
Roger S. Conrad needs no introduction to individual and professional investors, many of whom have profited from his decades of experience uncovering the best dividend-paying stocks for accumulating sustainable wealth. Roger built his reputation with Utility Forecaster, a publication he founded... More
My company:
Energy & Income Advisor
My blog:
Capitalist Times
View Roger S. Conrad's Instablogs on:
  • Nuclear Winter

    What if a third of the power supply for an entire US state were suddenly shut off? Would its residents find themselves in the dark, as they do routinely in developing nations?

    Vermonters may find that out as soon as March 2012, when the Vermont Yankee nuclear plant’s operating license runs out. One of the oldest nukes in the nation, Vermont Yankee is owned and operated by Entergy Corp (NYSE: ETR), the giant Mid-South-based electric utility that’s also America’s second-largest operator of nuclear power plants.

    Over the past decade-plus Entergy has acquired nuclear plants in four states outside its Arkansas/Mississippi/Louisiana/Texas base. The company has dramatically improved the plants’ safety and operating performance, including at Vermont Yankee. That’s enriched shareholders and provided low-cost power to the wholesale markets in those states, holding down rates to consumers.

    For the past several years the company has systematically re-licensed its plants, winning almost routine approvals from state and federal regulators. Vermont Yankee is next up, with the company applying for another 20 years to 2032. Like the other nukes, that process that requires approval from the Nuclear Regulatory Commission (NRC). But uniquely, it’s also required the OK from the Vermont legislature, under a prior deal struck by the company to store waste on site.

    This week the Vermont state senate dealt at least a temporary setback to Vermont Yankee re-licensing, voting 26 to 4 to reject it. The vote was in response to the furor over the appearance of the element tritium in sample water wells on the plant’s site and the company’s admission that it’s uncovered leaks in its underground piping system. Tritium has been shown to increase the risk of cancer, and critics have accused Entergy of misleading state officials on the risks at the plant.

    Rejection by the state senate doesn’t necessarily doom the Vermont Yankee to closure in 2012. Vermont’s upper house can take up the issue again in the future, at which time the company may well have resolved its tritium challenge, and more importantly its public relations problems. Governor Jim Douglas and the state’s utilities are major proponents of relicensing, and so is the NRC.

    Entergy CEO Wayne Leonard addressed the Vermont Yankee situation during the company’s fourth-quarter earnings conference call, indicating the governor’s call for a “timeout” on relicensing efforts. That seemed to indicate at least a tacit agreement between the governor and the company to allow investigations to be completed and give Entergy time to “restore trust and credibility,” i.e. to repair what had become a severe public relations problem.

    My view is that Governor Douglas will be able to work a deal to get the Vermont legislature to approve re-licensing and extend the plant’s operations several more decades. For one thing, the stakes are too high for the state to abandon a plant that not only provides more than a third of its electricity but is also its lowest-cost source, by far, of energy--particularly during a recession.

    To be sure, power could be replaced with a combination of out-of-state purchases, conservation measures and renewable energy construction. Unfortunately, though they’re very popular, renewables and conservation can in no way make up more than a sliver of what’s needed, particularly given the ridiculously short deadline of two years.

    That leaves massive purchases from out-of-state producers to pick up the slack. That would tighten up the power market in New England quite dramatically, a huge plus for the region’s biggest producer, Dominion Resources (NYSE: D). But it also means sharply higher prices for electricity in Vermont, as such purchases will be made at much higher prices than the below market rate Vermont Yankee is currently locked into until March 2012. And the cost of new wind and solar would be several times higher.

    Of course, Vermont has that reputation of being so green that its residents will be willing to take that hit, in the name of shutting down an allegedly dangerous nuclear power plant. And judging from the media coverage of the proceedings, that’s exactly what at least a very vocal minority of its residents want to see.

    Overcoming that will be a major hurdle for Governor Douglas. Then there’s the fact that Entergy says it hasn’t been covering its cost of capital to operate the plant and could shut it down without taking a hit to earnings. To date, those comments have almost certainly been little more than a bargaining chip for the company in its negotiations to fetch a higher price for Vermont Yankee’s output after relicensing. But it’s also a pretty clear signal from management that it will not accept a sharply lower return on its investment in the plant just to keep it open--which is likely the easiest way to get state politicians to agree to keep it open.

    Post-Nuclear Fallout

    The most likely scenario is for a deal to be worked out to keep Vermont Yankee open and selling power at a price that keeps electricity rates steady for Vermonters and also allows Entergy a reasonable return. But such an outcome is by no means certain. Consequently, it makes sense for investors to take stock on the likely winners and losers, depending on how this plays out.

    Obviously, the company in the bull’s-eye of this situation is Entergy. As noted, the utility has been effectively losing money running Vermont Yankee the past several years. And the cost of keeping the plant running past 2012 will almost surely be making what could be major upgrades to infrastructure to settle concerns about potential tritium leaks.

    As anyone who has followed the nuclear industry knows, operators of plants have borne a heavy burden of proof in the US since the Three Mile Island accident in 1978. And despite the vastly improved safety record of the industry--thanks mainly to dramatic consolidation of ownership over the past 10 to 15 years--the level of distrust still runs very deep among some Americans.

    As I’ve pointed out in this space, the Obama administration--with Energy Secretary Stephen Chu as point man--is now aggressively pushing the construction of new nuclear power plants in the US as a way to increase energy independence and reduce carbon dioxide (CO2) emissions from burning fossil fuels. In fact, anyone with a calculator and a basic knowledge of decimals can clearly see that only nuclear is capable of producing enough megawatts (NYSE:MW) to replace a meaningful amount of coal anytime soon.

    Nuclear power, however, is still an intensely emotional issue in some quarters. That’s why greenfield development is virtually out and why the only new nukes in this country for the next decade at least will be on sites of existing plants, such as the Vogtle site in Georgia being developed by Southern Company (NYSE: SO) and its partners.

    Nuclear emotionalism makes it almost a sure thing that Entergy will have to bend to get re-licensing approval for Vermont Yankee. The company, however, is motivated in one way to make a deal, mainly if re-licensing is coupled with approval of its plans to spin off the six reactors it holds outside of its core Mid-South territory as a separate entity dubbed Enexus.

    In the works now for well over a year, the Enexus spinoff has won all needed regulatory approvals except Vermont and New York, where regulators continue to delay their decision. Enexus would remain majority owned and operated by Entergy, with shares dished out to current Entergy shareholders. The new company would have about 5,000 (MW) of capacity serving unregulated markets in Massachusetts, Michigan, New York and Vermont. It’s also announced plans to buy more plants after the spinoff to boost its scope and reduce financial and credit risk.

    When the Enexus spinoff was initially announced, Entergy stock was bid up to $120 a share. Since then, the financial markets turmoil and regulatory delays have reduced the perceived value of the new company sharply. In fact, with Entergy shares now selling for less than $80, the market value of a future Enexus is arguably less than zero, particularly considering the improving prospects of the regulated Mid-South utility operation.

    The lack of perceived value for Enexus means that risk to Entergy shares from a complete failure of the spinoff is basically nil. The same goes for the risk of a closure of Vermont Yankee, which management confirmed in its fourth quarter conference call by stating that such a move would not have a “significant impact on earnings.”

    That leaves only upside for Entergy shareholders at this point. If Vermont Yankee is re-licensed and the company strikes a power sales deal with the state’s utilities, the Enexus spinoff can move ahead and the plant will begin adding to profits again. That, in turn, will lift the earnings and market value of both Enexus and Entergy. If no deal can be reached and Vermont Yankee is shut, the Enexus spinoff can still go through. And, because profits will be little affected, the market value will hold up as well.

    The only way Entergy shareholders can be hurt is if Vermont’s actions are copied by other states. Even this, however, shouldn’t have any real impact, as the federal government remains supportive of re-licensing efforts, and other states don’t have veto power--this includes New York, where the Indian Point nuke remains controversial with some voters.

    If Vermont does wind up shutting Vermont Yankee, it would tighten up power markets throughout the region. That would surely benefit Dominion Resources, which has considerable capacity in New England especially. We’d almost certainly see more imports from Canada, to the enrichment of power producers operating there such as Brookfield Renewable Power Fund (TSX: BRC-U, BRPFF).

    As for the nuclear power industry in general, permanent closure of the Vermont Yankee plant would almost certainly galvanize die-hard activists around the country. But with most environmentalists far more concerned about rescuing CO2 reduction efforts--and the Obama administration avowedly pro-nuclear--they’re not likely to make much headway elsewhere.

    The biggest potential losers are Vermont’s utilities, including Central Vermont Public Service (NYSE: CV), which are hugely dependent on purchases of energy from Vermont Yankee. The companies have been able to purchase power cheaply from the plant for over a decade as part of the deal under which they sold their ownership interests to Entergy. Losing that would dramatically ramp up their costs and force them to ask Vermont regulators to compensate, certainly no sure thing, particularly if the economy is still sluggish as they line up other sources.

    Investors are best served avoiding the hot spots if possible--unless the risks are contained, as is the case with Entergy. But where new plants do get built, they’ll boost their owners’ earnings while locking in huge, long-term sources of power with no CO2 concerns and very low variable costs. That’s a winning formula to enrich investors for years to come.

    Question of the Week

    Here’s my answer to a question I’ve received from readers this week. Please send your queries to utilityandincome@kci-com.com.

    • You list several stocks with five-letter symbols in your portfolio, some of which sport very attractive yields. Unfortunately, I can’t find any other source to back this up. Take CLP Holdings (OTC: CLPHY), for example. Yahoo! Finance says it pays no dividend. In fact, I’ve held this security for some time and have not received a dividend. What’s going on here?

    Two things. First, a five-letter symbol generally indicates a stock that trades in the US on the pink sheets rather than a major exchange. That’s the case with CLP.

    When I started in this business, trading on the pink sheets carried an extremely negative connotation. Quotes were actually printed out on sheets of paper that were the color pink. Trading was often by appointment only, and the majority of the companies listed were hardly substantial, if they truly existed at all.

    I’d still be suspicious of most securities traded on the pink sheets. But there’s another group of companies traded over the counter (OTC) that are anything but fly-by-night outfits. That’s the growing number of foreign-based companies that have become fed up with US regulation, particularly since the passage of Sarbanes-Oxley following the 2000-02 bear market.

    These companies, which include some of the oldest and strongest outfits in the world, have de-listed their securities from the New York Stock Exchange (NYSE) and other exchanges. As a result Americans can only buy them in their home markets, or they can buy those home market shares here in the US using the over-the-counter/pink sheets market.

    CLP Holdings is actually one of the easiest of these to trade. The power producer’s home market is Hong Kong, where it trades under the prestigious symbol “2”. But it also still carries an American Depositary Receipt (ADR), traded as “CLPHY” in the US, where it’s done an average of roughly 25,000 shares trading daily for the past several weeks.

    Unfortunately, if you look up CLP on Yahoo! Finance, you won’t find anything other than basic pricing information. And the same is true for every other OTC-listed company, including giant GDF Suez (FP: GSZ, OTC: GDSZF).

    The reason certainly has nothing to do with risk. One of the world’s largest energy companies, France’s GDF Suez has a market capitalization of nearly $100 billion and has been around since the time of Napoleon Bonaparte. CLP’s not quite that big but is still sizeable at a $16.5 billion market cap.

    It’s also a lot bigger and more substantial than the vast majority of US companies that are listed on major exchanges like the NYSE. Moreover, CLP’s three-year total return is 4.1 percent, more than 20 percentage points better than the S&P 500.

    Clearly, where a stock is listed is no indication of risk. Rather, dividend and other information simply isn’t collected for OTC-listed foreign stocks in the US. To get it, you’ve got to go to a source that’s plugged into the home market.

    That’s what we do in Canadian Edge. A growing number of Canadian companies, including income trusts that have converted to corporations, are either in the process of listing on major US exchanges or have already done so. However, an even larger number, including many of the most attractive for yield, are listed here only as OTC/pink sheets--and therefore don’t have dividend information posted at Yahoo! Finance and most other sources. CE’s How They Rate table provides live price quotes and dividend information, translated into US dollars for easy reference.

    Will Yahoo! Finance and other quote services ever provide accurate dividend information for OTC-listed foreign stocks? Don’t count on it anytime soon. Americans certainly need to invest some of their money overseas now. It’s where the growth is, and it’s the best way to protect yourself from a decline in the US dollar--and there are now a number of brokerages that will help you.

    On the other hand, some of the biggest brokerages apparently are actively discouraging foreign investment. One has even told its clients that it will no longer execute trades for investors who want to buy Canadian income trusts. That’s a firing offense in my opinion. But as long as investors let the big boys get away with it, they’ll keep doing it. After all, it’s another way to squeeze out profits in an otherwise tough market. But it will be difficult for some investors to get quote and yield information on foreign-listed securities traded OTC until they demand it.

    Your second point about not receiving a dividend is more specific to CLP but also applies to most foreign stocks in general. Simply, most don’t pay dividends US-style, i.e. a set amount quarterly or every three months. Rather, they generally pay an “interim dividend” in the middle of their fiscal year, based on what they expect to earn for the full year. Roughly six months later they will then pay a “final dividend,” based on the full year’s profits. The notable exceptions are Canadians, many of which pay out regular monthly dividends.

    As a result, it’s not uncommon to buy a foreign stock and not receive an actual distribution for several months. The tradeoff is you’ll get a half year’s worth of dividends when you do get paid.

    In the case of your CLP shares, however, I suspect you have a problem with your broker. The company does actually pay four dividends a year to holders of its ADRs. Over the last 12 months, these have been on May 6, June 22, September 22 and December 22. The May payment was the largest, a total of 11.869 US cents per ADR, while the other three payments were 6.707 cents per ADR. The next payment is scheduled for May, at the same rate as the year ago level.

    The ex-dividend dates--when you needed to own CLP to receive the next dividend--were April 14 for last May’s payment, May 29 for the June payment, September 1 for the September payout and November 30 for the December disbursement. Consequently, if you were holding CLP shares before Nov. 30, 2009, you should by now have received a dividend payment--and you have an issue with your broker. If not, look forward to your first payment in early May.

    Race to the Summit

    How best to ride this market? Join me and my colleagues GS Early, Elliott Gue, Yiannis Mostrous, and Benjamin Shepherd at the historic Hotel del Coronado for the 2010 Wealth Society Member Summit.

    You’ll have the extraordinary opportunity to meet one-on-one with me, Elliott Gue, Yiannis Mostrous, Benjamin Shepherd and GS Early and ask anything you want about how to keep and grow your nest egg.

    We’ll give it to you straight: the brightest trends and our best recommendations, and anything else you might want to know about how to profit in 2010 and beyond.

    Space and time limit us to 100 participants, so mark the date on your calendar: April 23-24, 2010, in San Diego, where they say it’s 72 and sunny every day of the year. You may find all details at www.InvestingSummit.com. Better yet, call 1-800-832-2330 (between 9:00 a.m. and 5:00 p.m. EST Monday through Friday) or go online now to reserve your seat at the table.




    Roger Conrad is Editor of Canadian Edge, Utility Forecaster, Chief Strategist of Portfolio2020, and Co-Editor of MLP Profits.



    Disclosure: "No Positions"
    Mar 01 10:30 AM | Link | Comment!
  • How Dirty Is Dirty?

    New York Times columnist, Princeton professor, scourge of the right and hero of the left Paul Krugman made a plain-vanilla economic observation yesterday on the new dynamics of the oil market (although he couldn’t avoid a political segue):

    One of the curious things about economic debate in the later Bush years was the conviction among many on the right that there wasn’t a bubble in housing, but that there was one in oil.

    We now know the truth about housing. But what about oil?

    Oil prices did spike to triple-digit levels in early 2008, then drop sharply. But think about the fact that right now, with the world economy still seriously depressed, oil is at $80 a barrel. This suggests to me that high oil prices are largely caused by fundamentals.

    And it also suggests that resource constraints will be an issue if and when we do get a full recovery.

    In other news, the Financial Times reports that China has surpassed the US as the largest customer for Saudi oil:

    Saudi Arabia’s oil exports to the US last year sank below 1m barrels a day for the first time in two decades just as China’s purchases climbed above that level, highlighting a shift in the geopolitics of oil from west to east.

    The drop in US demand for oil from the kingdom, traditionally one of its primary sources, is the result of lower energy consumption overall but also greater reliance on imports from Canada and Africa.

    China’s buoyant economic growth, meanwhile, is prompting Beijing to buy more Saudi oil, a trend Riyadh has encouraged through refinery joint ventures.

    That the decline in US demand for Saudi oil is a result of the recent historic recession is indisputable. But Canada--home to one of the largest concentrations of energy resources in the world--means the US can make permanent this reduction of reliance on oil exporters inconveniently located in hostile regions.

    The Canadian oil sands--at 172 billion barrels second only to Saudi Arabia in terms of estimated reserves--are of increasing strategic importance. No other industrial democracy in the world has an asset similar to the sands, and there certainly is no asset similar to it in the US. The “resource constraints” Krugman alludes to--which really are about new demand from China, in particular, and India--will be far easier to navigate if we take an open-minded approach to the oil sands.

    As we noted in the Feb. 2, 2010, MLM:

    The oil sands are fixed in the North American energy supply equation. It’s the source of 1.2 million barrels of crude per day, most of which is exported to the US. Extracting and processing bitumen from the sands is an energy-intensive process that requires both electricity and steam, which are usually generated by burning fossil fuels.

    This energy intensity and related emissions--as well as the massive and ugly footprint oil sands operations leave on the natural landscape--have raised concerns about the management of the resource at the activist level, of course, but also now at the official level.

    Oil sands development involves a complex set of constraints related to resource access, infrastructure requirements and, of course, environmental impact. The Athabasca region has become a flashpoint for North American debate about the future of climate change legislation.

    In an ideal world North America will wake up 10 years hence to a clean-energy paradise established by hard-working Yanks and Canucks and exported around the globe in a manner that raised living standards on both sides of the border.

    Something like that could happen, but it will require oil sands product to be burned before it comes about. One of the keys for US and Canadian policymakers when climate-change legislation finally is taken up is the impact of specific industries and practices on total greenhouse gas (GHG) emissions. Making the right changes in the policy and regulatory framework requires an understanding of facts.

    An interesting challenge to the common perception of the oil sands is raised by a June 2009 study by engineering firm Jacobs Consultancy, “Life Cycle Assessment Comparison for North American and Imported Crudes.” According to the study, life cycle GHG emissions for oil sands are comparable to domestic and imported conventional crude oils. Furthermore, about 75 percent of GHG emissions occur during fuel consumption and aren’t impacted by the source of the crude oil.

    The variance in the amount of GHG emissions generated in different types of oil production depends on how much energy is required to produce and process the oil. Some oil is just pumped out of reservoirs. Other reservoirs need injections of water or steam to retrieve the oil. Light oil requires less energy than heavy oil to be refined into transportation fuels. The amount of natural gas contained in the oil that may be flared or vented also contributes to overall GHG emissions.

    GHG emissions are also generated when transportation fuels are consumed in vehicles; this accounts for about 75 percent of all GHG emissions. Total GHG emissions from production to consumption are referred to as “life cycle GHG emissions.”

    The primary source of GHG emissions in oil sands mining is the energy required to mine and transport the oil sand, separate the oil from the sand, and process the oil. For in situ operations, the primary source of GHG emissions is the combustion of natural gas to generate steam. The oil sands industry has, through continual advancements in technology and energy efficiency, reduced GHG emissions per barrel by more than 30 percent since 1990. Cogeneration further reduces GHG emissions, and additional reductions are expected through the development of carbon capture and storage (NYSE:CCS) and new in situ extraction technologies.

    Cogeneration produces steam and electricity from a single source, and because cogeneration plants are sized according to a facility’s steam requirements there’s often more electricity produced than required.

    The excess electricity is sold to the grid, meaning less natural gas and coal needs to be used to meet electricity needs. This significantly reduces GHG and other air emissions. All existing oil sands mines and all but a few small in situ projects have cogeneration facilities (over 98 percent of oil sands production has associated cogeneration). Cogeneration in the oil sands provides approximately 18 percent of Alberta’s total electricity supply.

    CCS is well understood from a technical perspective but widespread implementation is limited by challenging economics and a lack of infrastructure. The Alberta government has committed CAD2 billion to CCS development, the federal government has committed CAD1 billion, and industry is also investing heavily.

    As the required infrastructure is developed, CCS has the potential to significantly reduce GHG emissions from the oil sands. It’s likely that initially CCS will be applied to coal-fired electricity facilities because of their larger, more concentrated sources of carbon dioxide.

    In situ operations require significant amounts of energy to generate the steam that’s injected underground to warm the bitumen before it can be pumped to the surface. Significant progress has been made in reducing the amount of steam required to achieve this, and several technologies could further reduce GHG emissions per barrel to levels equivalent to--or better than--imported conventional oil.

    Act Now

    Are you serious about investing in the Canadian story? Join Roger Conrad in sunny San Diego, California, April 23-24 for the 2010 Wealth Society Member Summit. You’ll have a chance to sit down with Roger one-on-one to talk about where to find the best ideas to generate total returns as Canadian income trusts convert to high-yielding corporations and how to position your portfolio for the year ahead.

    Join Roger and his colleagues GS Early, Elliott Gue, Yiannis Mostrous, and Benjamin Shepherd at the historic Hotel del Coronado--one of the top 10 resorts in the world according to USA Today, one of the top 20 hotel/spas in the world according to Travel + Leisure, and the No. 2 place in the world to get married, according to the Travel Channel.

    And on April 23-24, Coronado Island will also be the best place in the world for relaxation and profit. We’re expecting 72 degrees, sun and fun. You may find all details at www.InvestingSummit.com.

    Call 1-800-832-2330 (between 9:00 a.m. and 5:00 p.m. EST Monday through Friday) or go online now to reserve your seat at the table. Space is limited.




    Roger Conrad is Editor of Canadian Edge, Utility Forecaster, Chief Strategist of Portfolio2020, and Co-Editor of MLP Profits.


    Disclosure: "No Positions"
    Feb 25 10:17 AM | Link | Comment!
  • Earnings Season

    Blame it on Sarbanes-Oxley and subsequent populist-inspired attempts by Washington to protect investors from Wall Street fraud: Year-end filing has become so regulation-driven that fourth-quarter earnings reporting season lasts literally the entire first quarter.

    As of late February fully one-third of the 216 companies tracked in Utility Forecaster have yet to release numbers. At least half won’t until sometime in March, with the last filing on the 30th.

    Until a company does report, all we can do is infer the health of its underlying businesses based on other data and developments. Nothing sends a positive signal like a robust dividend increase. And a significant debt refinancing at a good rate, a credit-rating boost, an acquisition announcement, or even a rally in a company’s bonds can all be signs of good things to come.

    But only the hard data will set all concerns to rest--and in at least some cases we’re going to have to wait a while to get it.

    The good news is we do have enough data to draw some broad conclusions about the health of essential-service industries in general and where they fit into an income investing strategy here in February 2010.

    Note Utility Forecaster has the details on individual companies, while Portfolio companies reporting this week are reviewed below for subscribers. Here are the highlights.

    • Dividends and balance sheets remain well protected.

    Of the roughly 150 US electric, natural gas and energy infrastructure companies tracked in UF, only five have cut dividends since the market peaked in mid-2007. That’s in part because these companies provide essential services, demand for which never fluctuates much.

    But it’s also because of the systematic de-leveraging and cutting of operating risk in these sectors since the 2001-02 bear market. In fact, the dividend-cutters were all companies that were still levered up and participating in non-regulated businesses.

    The best news about fourth-quarter earnings thus far is that dividends and balance sheets remain well protected industry-wide. The typical power utility now has a payout ratio between 50 and 60 percent, with 90 percent or better of its earnings coming from either regulated operations or long-term contracts with locked-in revenue.

    As for balance sheets, interest costs have dropped markedly over the past year, and companies have pushed out debt maturities, eliminating near-term refinancing risk.

    With very few exceptions, utility dividends are as safe as they’ve been in many years. That’s further demonstrated by the fact that 90 percent of the regulated companies I cover have boosted distributions at least once in the past 12 months. And while credit raters are skeptical as ever--often wrong-headedly so--companies’ borrowing costs continue to decline, pointing the way toward even stronger balance sheets and a low cost of capital to fund future expansion.

    • Cost-cutting, not revenue growth, is still driving the bottom line.

    A handful of reporting companies posted fourth-quarter 2009 revenue above last year’s. This group includes wireless communications giants like AT&T (NYSE: T) and Verizon Communications (NYSE: VZ), who continue to add new customers at their rivals’ expense and sell more data services through the proliferation of smart phones.

    Verizon’s wireless data sales surged 45.9 percent, continuing a string of similarly robust growth in recent quarters. On the other hand, Verizon’s overall revenue growth was only about 10 percent, as its wireline business continued to feel the effects of the recession.

    In the power sector, the slump in the industrial sector was again a heavy drag on results, with most companies posting year-over-year declines in the double-digits. That was especially true in what was once America’s industrial heartland of the Midwest and Northeast. But recovery is even sluggish in the Southeast, the region where heavy industry is increasingly moving thanks to better infrastructure, lower-cost labor and more favorable regulation.

    Southern Company (NYSE: SO) noted a dip in industrial sales from the third to the fourth quarter. And only Entergy Corp (NYSE: ETR) posted a significant year-over-year increase in industrial sales, realizing 7.1 percent growth.

    Looking out over the next several years, Entergy, Southern and others will see a mighty boost in sales from industrial users. For now, however, that’s hurting, not helping, revenue growth. And that means power companies beat Wall Street expectations during the quarter mainly on the strength of cost cutting, whether from greater efficiency in power plant and transmission operations, debt reduction or the old fashioned way with layoffs.

    The one essential-service sector that appears to have a sustainable revenue growth model for 2010 is midstream energy. These companies are using their record-low cost of capital to build and acquire assets such as energy pipelines, storage facilities and processing centers at an unprecedented pace. These assets immediately add to revenue and cash flow, which flow through to distributions, particularly if companies are organized as master limited partnerships.

    Here too, however, maintaining that revenue growth in 2010 and beyond will depend on the economy getting back on its feet. In the meantime, as is the case with other companies, maintaining efficiency is critical to health.

    • Not all overseas operations are helping earnings.

    Spectra Energy’s (NYSE: SE) midstream energy operations in Western Canada provided a big lift to its fourth quarter 2009 earnings thanks to better gathering and processing revenues, but also because of the jump in the Canadian dollar’s exchange value versus the US dollar.

    Companies with operations in Asia and parts of Latin America benefited from reviving economic growth in those countries as well. In contrast, the recent drop in the euro and the Continent’s slumping economies have hurt US companies invested there. This dichotomy is likely to continue well into 2010.

    Note that companies like Enel (OTC: ENLAY, ESOCF) and Telefonica (NYSE: TEF) are based in Europe and priced in euros but have extensive operations in Latin America and Asia that continue to drive growth. Any selling by association to Europe is a buying opportunity.

    Telefonica  is teaming up with China to spur growth, both through a growing interest (currently 8.37 percent) in China Unicom (NYSE: CHU)--the country’s No. 2 operator--and via an alliance inked this week with major Chinese equipment maker ZTE Corp (Hong Kong: 0763, OTC: ZTCOF) to sell handsets in Latin America.

    • Capital spending is still a positive for earnings.

    The utility formula for growth is to buy or build revenue-generating infrastructure and earn a return on the investment. If the return is fair, it will boost revenue, earnings, dividends and, ultimately, share prices. If it’s not, earnings, dividends, share prices and even solvency may be at risk.

    The linchpin is regulation. Since the bottom in late 2002--when some two dozen utilities were either in Chapter 11 or on the brink of it--regulators and companies have generally worked together to ensure capital investment is rewarded in a way that doesn’t lead to rate spikes.

    This regulatory compact continues to hold in every state but one, Florida, where Governor Crist took up utility-bashing in a desperate attempt to shore up his apparently fading chances of reaching the US Senate. As a result, capital investment continued to add to bottom lines of most regulated power companies in the fourth quarter of 2009.

    Looking ahead to 2010, most utilities have throttled back rate increases until the economy gets a bit stronger. As a result, capital spending will likely have less of an impact on earnings this year than it did in 2009 for most regulated businesses.

    In contrast, capital spending in what are mostly unregulated businesses, like wireless communications and midstream energy infrastructure, should continue to flow to the bottom line.

    • Commodity-related businesses are showing signs of rebound.

    Year-over-year comparisons for energy producers--and unregulated power producers--were generally unfavorable in the fourth quarter. That was even true of companies that ramped up their output last year.

    Meanwhile, businesses with exposure to commodity prices have also found their credit ratings increasingly under attack. Credit raters have taken an exceptionally gloomy view of where energy prices are headed and are imputing much lower returns for 2010. Ironically--but not too surprisingly given raters’ record of perpetually fighting the last war rather than preparing for the next one--commodity-related businesses are showing distinct signs of a rebound.

    Weak industrial sales and still-low natural gas prices will continue to weigh on electricity prices in the spot market at least in early 2010. But energy prices are well off last year’s lows, and oil and gas producers are reporting sequential profit gains. Power markets are supported by the fact that long-term contracts now account for the majority of sales, as well as demand for renewable energy that’s now mandated by 36 states and the District of Columbia.

    Even if carbon dioxide regulation doesn’t happen in this country, the old baseload coal plants are wearing out and in dire need of replacement. Both Exelon Corp (NYSE: EXC) and Progress Energy (NYSE: PGN) have announced plans to take a huge amount of old coal capacity offline the next few years rather than upgrade with scrubbers.

    Finally, reviving economic growth means more demand for electricity. Recovery still looks like it will be slow. But any company still operating a commodity-related business after the past couple years’ devastation is now battle-hardened and capable of waiting until economic growth revives. That’s a major reason why so many resource companies have issued much higher guidance for 2010 and 2011 than they earned in 2009--and it’s a good reason to stay bullish on these companies.

    • The recovery is not yet bailing out weak companies.

    Just as the strong have stayed strong the past two years, the weak economic environment is still battering weak companies. The old adage that if you really need credit you can’t get it certainly holds true still, and operations that slumped in previous quarters did again in the fourth of 2009.

    That’s the clear message from perusing earnings of companies like Otter Tail Corp (NSDQ: OTTR), who’s strategy of investing in virtually anything outside its core power production business has backfired, big time, during the recent recession.

    Management is still holding the dividend and projecting earnings for 2010 that would cover it. But its operations in plastics, health care and manufacturing are still bleeding red ink, and in December the company was forced to issue six-year debt at the whopping rate of 9 percent to pay off a credit balance. Some operations, such as food ingredient processing, are doing well. But with a payout ratio of 167.6 percent, owning Otter Tail is clearly a bet that the economy will bail you out. And the yield of less than 6 percent is hardly compensation for the risk it won’t.

    The clear message is it’s still absolutely critical to unload any investment where the underlying business is weakening. That’s even true for companies that yield a lot more than Otter Tail and therefore compensate better for the risks.

    This economy is in far better shape than it was a year ago and, despite challenges in some sectors such as commercial real estate, it will improve as the year goes on. That means companies that have stayed strong the past couple years are less and less likely to stumble. It doesn’t mean, however, we can count on weaklings to make it back. Sell them.

    Question of the Week

    Here in Northern Virginia we’re still digging out from the recent “snowpocalypse.” As a result, I haven’t been able to get to all my reader correspondence this week. But here’s my answer to a question I’ve encountered more than once over the past week. Send your question to utilityandincome@kci-com.com.

    • You’ve written that dividends paid by Canadian trusts held in IRA accounts should no longer be subject to the 15 percent withholding tax in Canada. Can you provide any more detail?

    The US-Canada tax treaty was last amended in December 2008. Details are available on the Revenue Canada website, as well as from the US Treasury Dept.

    Based on a plain-English reading of the relevant passages, Canadian equities held in US IRAs should not be subject to the 15 percent withholding tax as of Feb. 1, 2009. Conversely, Canadian investors who hold US stocks in their tax-deferred retirement accounts are also not subject to the tax.

    In our view, US investors are being withheld for three main reasons. First, tax treaties are generally obscure documents. Many brokers and transfer agents we’ve spoken to have been genuinely unaware of these developments and are now acting to make needed changes.

    Second, avoiding withholding depends on having the stock or trust registered in the right place. This is also a job for your broker and many are acting to correct the situation now.

    Third, the tax treaty applies to Canadian equities held in IRAs. And, despite trusts’ statements to the contrary, some brokerages don’t consider them to be equities. The good news is this problem will go away as soon as trusts convert to corporations, thereby coming under these brokerages’ definition of equities. The bad news is until then dividends will still be withheld at 15 percent.

    The biggest problem with this issue is confusion. Fortunately, since we took our first whack at this hornet’s nest, a number of investors have contacted us at Canadian Edge stating they’ve been able to resolve this to their satisfaction just by working with their broker. That remains my strongest advice now.

    You may not be able to claw back what’s been withheld in 2009. You may not even get your broker to agree that trusts are equities and shouldn’t be withheld. Some may even refuse at first to exempt Canadian common stocks from withholding. But you won’t get anywhere without at least trying.

    For more on this issue, see the weekly compliment to my Canadian Edge advisory, Maple Leaf Memo.

    Race to the Summit

    How best to ride this market? Join me and my colleagues GS Early, Elliott Gue, Yiannis Mostrous, and Benjamin Shepherd at the historic Hotel del Coronado for the 2010 Wealth Society Member Summit.

    You’ll have the extraordinary opportunity to meet one-on-one with me, Elliott Gue, Yiannis Mostrous, Benjamin Shepherd and GS Early and ask anything you want about how to keep and grow your nest egg.

    We’ll give it to you straight: the brightest trends and our best recommendations, and anything else you might want to know about how to profit in 2010 and beyond.

    Space and time limit us to 100 participants, so mark the date on your calendar: April 23-24, 2010, in San Diego, where they say it’s 72 and sunny every day of the year. You may find all details at www.InvestingSummit.com. Better yet, call 1-800-832-2330 (between 9:00 a.m. and 5:00 p.m. EST Monday through Friday) or go online now to reserve your seat at the table.



    Roger Conrad is Editor of Canadian Edge, Utility Forecaster, Chief Strategist of Portfolio2020, and Co-Editor of MLP Profits.



    Disclosure: "No Positions"
    Feb 23 10:22 AM | Link | Comment!
Full index of posts »
Latest Followers

StockTalks

  • U.S. REIT Space Short On Bargains But WP Carey Looks Attractive $WPC http://seekingalpha.com/a/1ncop
    3 days ago
  • More on why we cashed out $SCG: http://bit.ly/1w5KgYu
    3 days ago
  • Booked 33.2% gain in $SCG from 11/01/13. Like deal with $D, but what does it imply about Summer project? Risk-reward skewed to downside.
    3 days ago
More »

Latest Comments


Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.