OGE Energy Is A Speculative Play At Best

| About: OGE Energy (OGE)
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Summary

OGE has a number of red flags when looked at as an investment partner for a dividend growth investor.

OGE management has promised very attractive dividend growth, but can it deliver?

If you wish to speculate, OGE seems to be selling at a good price.

OGE Energy (NYSE:OGE) is an electric utility that raises a number of red flags for me as a dividend growth investor. OGE is another utility that I wrote about in this article but hadn't done a full analysis on. After a full analysis I can't recommend it as anything but a speculative play.

Is OGE a good investment partner?

Robert Allen Schwartz in the comments to my article on PPL, mentioned OGE and that it has raised too many red flags for him to be comfortable owning it. Determining if it was in fact a good investment partner and a good buy was important since I had implicitly recommended it in my previous article on a group of utilities.

On the company website I found this presentation. Read the whole thing, but I have included the slides that provide information for my checklist.

The first item on my checklist is that the company operates in a market that is growing or at least supports earnings growth for the company. For a utility company that means it has a service area with a growing population or whose income is growing and that it has a regulatory environment that allows the company to make a reasonable profit and grow its earnings over time. The slide below shows that OGE is in an area with a growing population and economy.

The problem with the market item is that I see many issues in the regulatory environment. For one recent project, the scrubbers for the Sooner unit, OGE spent 16 months trying to convince the Oklahoma Commerce Commission, and at the end of that time the project was denied approval. While it did eventually get approval for the project, spending more than a year only to get a project rejected indicates a strained regulatory environment. And from what it has said in various presentations, OGE considers Arkansas the harder regulatory environment. This is a red flag for me, and I suspect it likely was for Robert as well.

This slide shows a breakdown of OGE earnings. Earnings look okay, but note the interest expense here, which is close to 50% of the profit.

This slide shows the management's predication for earnings growth going forward. It seems like a reasonable number for a utility company. It also shows the management's guidance on dividend growth - more on that later. This also looks like management has a reasonable plan for future growth. Note also that the company does indicate that the Sooner scrubber decision was not made until May of 2016. Also note that much of the environmental compliance work is being funded from distributions from Enable (NYSE:ENBL) (which cause a big impairment charge in 2015).

The next item to look at on my checklist is debt and debt management. Unfortunately, UGE doesn't tell me its credit rating, which I find troubling. I do see the interest expense at $140 million, which seems somewhat high to me, but without a credit rating I can't tell what it really means.

Looking on Morningstar I find this report. The graph at the bottom of the page is the most troubling - particularly the line item that shows it has significantly lower cash flow for its debt level than is typical for a utility company.

This final slide shows the company history of dividend growth plus management guidance on forward growth. I certainly like to see such a chart, and the numbers themselves look good. However, for this to really be a plus for me and the company, the company has to have the earnings growth to support the level of promised dividend growth. And even if it grows earnings at the top of its estimate, they will still fall short of covering a 10% increase in the dividend. With the payout ratio at nearly 70%, I don't see how they can raise the dividend by 10% for very long when earnings are growing around half that amount.

The final thing I want to look at, because it really touches on all the items on my checklist, is Enable. That MLP has caused issues for OGE back in 2015 (and for its other owner CenterPoint CNP as well). OGE's solution to this is to buy out CNP. I find that to be another red flag. Sure, they are likely to get a better price since Enable is struggling to some extent, but how much better a price? And how are they funding it?

The debt issue is a big red flag for me. Companies that have good credit ratings prominently display them. I haven't had a problem finding a reference to a utility company's credit rating, at a minimum they will tell you they have investment grade credit ratings even if they don't list what they are specifically. OGE doesn't say anything as far as I can find. A search on the web doesn't produce any current information, just what it was in 2011.

Given that three of my four checklist items have red flags, I don't think OGE is a good investment partner. I will evaluate a price for those who might wish to take a chance that things will work out for OGE despite the issues it seems to be having.

What's a good price?

To figure out a good price, I do a DDM calculation using my Excel®-based DDM calculator. (You can see the web-based calculator I based it on here and read a discussion on how the formulas were developed here.) I use the usual values when evaluating OGE, but because I don't think it can maintain the managements projected dividend growth, I will use half of its prediction instead.

Between the issues with Enable and credit ratings I will want an additional 15% margin of safety, giving me a price target of $34. Given that the current market price is just above $33, for those inclined to speculate a bit, OGE is a buy. I also wouldn't recommend more than about a half position size. The two ways I manage risk for companies that are on the edge of my risk tolerance envelope is to buy them cheap and buy only a little.

Can options help?

Given the issues that OGE has, a big price drop might result if they develop into full-fledged issues. If these issues do develop into problems, I wouldn't want to be short a put obligated to buying at a price, because my valuation number could be dropping as fast as the market price. I would not recommend selling a put on this stock at this time.

The call options seem to be very lightly traded, but on the March expiration, the $35 strike seems to offer a reasonable premium. Definitely use a limit order, but you should be able to get at least $0.50 for it, which is more than the pro-rated dividend for that period of time. Because of the low volume, actually selling a contract at a good premium can be tricky, so only do it if you are comfortable with using limit orders.

Conclusion

Robert Allan Schwartz was correct that there are a number of red flags with OGE. I think that the market has priced those issues in, so if you are adventurous, OGE could represent an opportunity. It is, however, not without risks, and investors might not be willing to take those risks given the likely returns from a utility stock.

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Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. The price I call fair valued is not a prediction of future price but only the price at which I consider the stock to be of value for its dividends.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.