- CenterPoint Energy is transforming itself into a pure-play utility, and could see meaningful growth over the next several years.
- It remains relatively undervalued, and shareholders could reasonably see a 17% total return over the next 12-18 months.
- I also highlight the valuation, dividend, balance sheet, and risks worth considering.
Utilities deserve a place in most defensive portfolios for the steady growth and income that they can provide. While this sector has gotten expensive in recent months, I still see pockets of value here and there. Such I find the case to be with CenterPoint Energy (NYSE:CNP), which is still trading at what I see as an attractive entry point. In this article, I evaluate what makes CNP a buy at the present level, so let's get started.
Why CNP Is A Buy
CenterPoint Energy is an electric and gas utility based in Texas. It serves more than 7M metered customers in Arkansas, Indiana, Louisiana, Minnesota, Mississippi, Ohio, Oklahoma and Texas. It's worth noting that CNP recently entered into a transaction with Energy Transfer (ET) to sell Enable Midstream (ENBL), in which it has a 54% equity ownership. In 2020, CNP generated $7.4B in total revenue.
Starting off with share price performance, CNP has underperformed the broader Vanguard Utilities ETF (VPU) over the past 3 years. As seen below, CNP has generated a total return of -3.4%, compared to the 40% return of VPU over the same timeframe.
(Source: Seeking Alpha)
I see this underperformance as being underserved, given the strides that management has made on this business in years. As seen below, CNP's revenue has held steady over the past 5 years, at around $2B per quarter. Meanwhile, investments in operating efficiencies have paid off, as CNP's operating margin has improved from around 13% five years ago, to 16.5% for the full year 2020.
This strong performance was reflected in the fourth quarter results, with adjusted EPS landing at $0.29, which beat analyst expectations by an impressive $0.08. CNP also attained a 1.5% YoY revenue growth, to $2.05B, amidst a record surge in COVID infections during Q4'20. Looking forward, I see reasons to be optimistic, as management recently boosted FY'21 EPS guidance, to $1.25 at the midpoint, and reiterated a 6-8% utility EPS growth rate, and a 10% rate base compound annual growth rate.
(Source: Q4'20 Investor Presentation)
Perhaps what is on everyone's minds is the deep freeze that Texas suffered through in late January, and the related impact to CNP. Judging by the overall share price performance, it appears that the market regards this as a non-issue, as CNP's current share price is sitting higher than the $21.50 level in late January and early February. Management also expressed confidence in being able to resolve the issue of the natural gas price spike, without the need for dilutive equity issuances, as noted during the recent conference call:
"More importantly for our investors, we will not have to seek any incremental equity to handle our increased storm-related liquidity needs. As we have mentioned many times, we are fortunate to work in constructive regulatory jurisdictions and fully expect these costs to be recoverable in a timely manner.
And in many of our jurisdictions, where these costs are the largest, we already have the ability to recover some carrying costs. We are in the process of working with all of our regulators on that."
In addition, Morningstar has a favorable view of CNP's decision to divest its midstream business. That's because this will provide a capital infusion as CNP expected to invest over $13B in infrastructure over the next five years, including the build-out of renewable assets. Morningstar expects near-term pressure on earnings due to this divesture, but estimates 9.6% average annual EPS growth through 2025. This is what Morningstar noted in its latest research report:
"After the dividend cut in 2020 due in large part to the impact of COVID-19 on cash flow from its investment in Enable, we now believe CenterPoint's dividend is secure due to diverse electric and gas utility earnings. CenterPoint's moat and the security of the dividend will be further strengthened following the expected divestiture of the company's midstream investments."
Meanwhile, CNP maintains a sound balance sheet, with $147M in cash, and a net debt to EBITDA ratio of 5.5x, which is within the 6.0x-level that prefers to see for utilities. This is further supported by a solid investment grade BBB+ credit rating from S&P, thereby giving it access to low interest rates on debt.
Notably, the dividend was halved last year, and I see CNP's share price weakness since the end of 2019 as still being reflective of that. However, the current 2.7% dividend yield is well-covered, at a 46% payout ratio. Plus, management has demonstrated a willingness to grow it with the recent 6.7% dividend raise, to $0.16 per share.
Turning to valuation, CNP remains attractively valued compared to its peers. For comparison, I use an apples-to-apples EV/EBITDA ratio since Enterprise Value includes both debt and equity value. As seen below, CNP's 12.3x EV/EBITDA compares favorably against Duke Energy (DUK), WEC Energy Group (WEC), and sits just above Consolidated Edison's (ED) 11.4x.
(Source: Seeking Alpha)
Analysts also see CNP as being undervalued, with a consensus Buy rating, and an average price target of $25.12. Morningstar has a price target of $25.00. Investors could be looking at a potential 17% total return, based on share price appreciation to the price target, the annual dividend yield, and the guidance for 7% annual EPS growth.
Risks to Consider
It's worth noting that utilities, including CNP, are known for tapping equity markets to fund capital investments. This results in dilutive equity issuances, which CNP has done in recent years. While equity issuances can be accretive if done at the right prices, it does mean that CNP will be reliant on a healthy share price to fund future growth. This is something worth considering.
(Source: Seeking Alpha)
CenterPoint Energy has seen some big changes recently, including the divestiture of its stake in Enable Midstream, and the large dividend cut last year. Looking forward, I see it as being a more focused "pure-play" utility, with more cash flow to grow its business as a result of the reduced dividend.
Meanwhile, it maintains a strong investment grade credit rating and could see a forward earnings growth rate in the high-single digits. Lastly, CNP's dividend is now well-covered and growing again. Perhaps the market is still punishing CNP for the dividend cut last year, and I see now as being a good entry point for long-term-minded investors.
This article was written by
I am Gen Alpha. I have more than 14 years of investment experience, and an MBA in Finance. I focus on stocks that are more defensive in nature, with a medium- to long-term horizon.I provide high-yield, dividend growth investment ideas in the investing group Hoya Capital Income Builder. The group helps investors achieve dependable monthly income, portfolio diversification, and inflation hedging. It provides investment research on REITs, ETFs, closed-end funds, preferreds, and dividend champions across asset classes. It offers income-focused portfolios targeting dividend yields up to 10%. Learn more.
Analyst’s 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.
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