Avista Corporation, It's Not Just Water Over The Dam

| About: Avista Corporation (AVA)
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Summary

AVA has been paying a growing dividend for 14 years.

The company has a good customer base with a good mix of generation technologies.

AVA has the growing income to support its continuing dividend growth.

Avista Corporation (NYSE:AVA) is a gas and electric utility with a service area in the Pacific Northwest of the United States. Given its current market price, its growing customer base and growing dividend, it is a buy.

Is AVA a good investment partner?

To see if AVA would pass my good investment partner checklist, I examined this presentation from its website. Read the whole thing, but below I will include those slides that address the 4 items in my checklist. For the most part, I want management to explain to me easy-to-find and easy-to-understand ways why it is a good investment partner. If I have to search extensively for information that a company which wants me to invest with it should tell me, I consider that as a negative. Having to hunt for information won't preclude finding that a company is a good investment partner, but it will weigh against it.

This first slide shows that AVA is operating in a growing market in the Pacific Northwest and so it addresses the first item in my checklist. One thing that leaps out at me is that while there are 1.6 million people living in its service area, it serves far less than that. That seems like a large area of potential growth. The high customer satisfaction should also help with attracting more customers. Elsewhere I will want to see evidence that management is taking active steps to add to its customer base in its service area.

As a regulated utility, having effective relationships with regulatory agencies is also important to grow the market. What I want to see and this slide shows is that AVA is effective at making the case to the regulatory agencies to increase rates. I also see that it structures its requests to ensure it remains profitable, get a good return on its investments and frame the request so that the regulatory agencies are likely to approve the request. I also see that the efforts of AVA to get rate increase are mostly successful.

With these first two slides, AVA has addressed the market item from my checklist by showing that it has a stable and growing market within which to operate. An investment pattern needs such a market so that it can grow its revenues and profits.

Earnings and earnings growth are important. Here we see the growth in earnings since 2012. Also included are the earnings from discontinued operations and the effect that selling them had on overall earnings. I like that the growth from 2012 to 2016, if I use the bottom end of the projected 2016 earnings estimate, is just over 45%. Even with the decrease in earnings because of the asset sale in 2015, that is a good rate of earnings growth. Growing profits are important to me as a dividend growth investor, because with growing profits, a company has the ability to grow its dividend.

This slide contains information on how AVA plans for future growth. I think a plan that focuses on modernizing its current infrastructure, being selective with acquisitions and new product development and working to extend access is a plan that positions AVA for cost-effective future growth. Developing new products, like LNG is also a good way to attract new customers and increase revenue and earnings. By having a history of growing profits in the past and a solid plan to grow profits in the future as well as a recognition of where it has the best opportunities to grow profits, a company gets a positive result for the earnings item on my checklist.

On this slide AVA presents some data on how it manages its debt. I like that it has a fairly balanced capital structure. It's good that there are no major maturities until 2018, which gives the company time to issue new debt or pay down that debt. Moody's has AVA with a credit rating of Baa1, so its investment grade. AVA seems to be doing a good job of managing the cost of its debt, timing debt maturities and using equity sales to keep the debt levels manageable.

Part of managing debt well is to spend cash wisely. From this slide I don't see any red flags. One concern I would have is if the company was spending a lot of money on environment items. Given that environmental items produce little additional income (more efficiency will save on costs, but most such items are done to satisfy political concerns and not to generate more revenue or profits), I take it as a positive sign that the company is not spending much money on them.

Given the large difference between the number of potential customers and actual customers, the more than $50 million each year on customer growth looks like a very profitable investment to me. Coupled with the high level of customer satisfaction it has with existing customers, this will help grow revenues and profits.

One concern I do have with AVA is that it is in the Pacific Northwest and has a lot of hydro-power generation. I remember reading some time ago about the push to remove dams for various ecological reasons. As dam removal could be an issue, I want to see what the company says about its dams.

This is the only slide I can see that addresses anything on dams, and it is talking about rehabbing and upgrading two dams. I am not sure if the lack of information on dams is a sign that no dams owned by AVA are scheduled to be decommissioned or not. I found this news article, and while it does talk about several dams that AVA is upgrading, it does not mention any dams that are being removed. So I can find no data to back up my concern that the company may have to remove dams and find a way to replace the power generated. I am not sure how long ago I read about dam removal, but I did find this page on Wikipedia and it lists no dams that seem to be owned by AVA.

I very much like it when a company shows me that it considers dividend growth important and with this slide AVA does exactly that. It helps my portfolio income growth to have lots of companies growing their dividends per share by 4% or more a year, which is what AVA has done since 2012. A stock paying me 4% a year in dividends will actually help my portfolio income grow faster than that as the dividends will be used to purchase additional shares that also produce dividends.

Looking at the CCC List, I can see that AVA has grown its dividend for 14 years. 14 years of dividend growth coupled with no cuts in the dividend since 1999 at least, exceeds my minimum requirement for length of dividend growth for a utility. With a yield of around 3.4% and a 5-year DGR of 4.5% that gives a Chowder number barely under 8, which is a good number for a utility.

The last slide from the company presentation and the entry from the CCC list combine to produce a positive result for the dividend growth checklist item. Since dividend growth needs to be supported by each of the other items on the checklist, having a positive result for every item means that I can consider AVA to be a good investment partner.

What's a good price?

To figure out a good price, I do a DDM calculation using my Excel®-based DDM calculator (pictured above, you can see the web-based calculator I based it on here and read a discussion on how the formulas were developed here).

For AVA, I used the bottom end of the historical dividend growth rate that the company presented. I use the current declared quarterly dividend annualized to get a yearly dividend of $1.37. I use my usual terminal dividend growth rate for utility companies of 3% and as a discount rate I use my target income growth rate of 6.4% (which is twice the long-term inflation rate). DDM then calculates the PV of the predicted dividend payments to be $43.43. Since the current market price is around $39.50, AVA is trading at a good value.

Can options help?

When writing a put on AVA, the February expiration date looks good. The $40 put will get you a premium of more than a $1 for holding just about a month. With about a 50/50 chance of getting the shares assigned, that will give you the shares at a net cost under the current market price. If you don't get assigned the shares, the $1 or more premium is nice yield for a month. The options are thinly traded, so make sure to use limit orders to avoid any surprises.

To get a good premium for writing a call, you need to go out to the March expiration date. With a limit order you should be able to get at least $0.90, and maybe even push it to $1, for the $40 call. With about a 50% chance of losing the shares, that might be too risky for some, depending on their cost basis. If you want to be wild and crazy, while getting a big bunch of cash immediately, you can write a call at the $35 strike and get at least $4. However, if you do write that contract, you most likely will see your shares called away as the Delta is 1.0. If the price of AVA fell from where it is now, you might be able to buy the contract back at a profit, as most of its value is now intrinsic (that means that the value of the option is only a little more than the difference between the market price and the strike price).

Conclusion

AVA is a utility with reasonable growth prospects. It is currently priced to buy because the market price is about 10% below the present value of its discounted future dividends. AVA is currently on my watchlist awaiting the cash to buy some shares.

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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.