TEG is a utility holding company that has a combination of regulated electric/gas operations and unregulated energy supply and services business.
- Revenue: Increasing trend in revenue with average growth of 33.6% (28% standard deviation). This is extremely high volatility for last 10 years. It shows that corporation’s revenue is not consistent. Investors need to understand why is this so?
- Cash Flow from operations and net income: In general, since 2003, corporation’s net income is higher than the cash flow from operations. If net income is higher than cash flow from operations, where is the income coming from?
- EPS from continuing operation: In general, since 2003, the EPS is trending downwards.
- Dividend per share: Dividends per share are consistently growing very slowly for the last 10 years. In fact, the dividends have grown faster for 2006, 2007, and 2008.
Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. I have discussed this in more detail at Dividend Tree. This is calculated as arithmetic average based on price, yield, EPS growth rate, payout factor, gross margin, operating margin, and financial leverage. The risk number for risk-to-dividends is 2.43. This is in high risk category as per my risk scale.
Quality of Dividends
This section measure the dividend growth rate, duration of growth, consistency over a period of past ten years.
- Dividend growth rate: In general, for the 10-year period, the average dividend growth (3.2%) is lower than average EPS (7.6%). The slower growth rate in dividends is inline with a typically characteristics of utility stocks. However, since 2006, the dividend growth has increased (9.65% and 7.20%) while the EPS growth has been negative. So where is the dividend increase coming from?
- Duration of dividend growth: Dividends have grown consecutively for last 51 years
- 4 year rolling dividend growth rate for past ten years: It is less than 10% on 4 year rolling basis.
- Payout factor: Until 2005, it has been trending down from 90% to 54%. This was a good sign. However, since 2006 the payout factor has been increasing and now stands at more than 100%.
- Dividend cash flow vs. income from MMA: Here, I am analyzing how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) TEGs is yielding 11.0% (b) MMA yield is 3.4%. Considering the historical average growth rate of 3.2%, TEGs dividend cash flow at the end of 10 years is 3.18 times MMA income. However, the corporation’s financial health shows that existing dividend of $2.68 per share is not supported by earnings, net income, and cash flow. Therefore, I am not including my expected dividend growth rate.
Fair Value Calculation
This sections determine the what price should I pay to buy a given stock
- Net present value (NPV) price based on 20 year DCF: $25.3 (It assumes $2.48 dividends per share).
- Average high yield price calculated based on past 10 years: $40.1
- Pricing based on past 10 year relative price-to-earnings ratio. $42.4
- Pricing based on price-to-earnings ratio of 12: $34.1
- Graham number: $39.5
The range of fair value is calculated as $32.9 to $36.3. This determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value).
- The strong argument for TEG is that it is a dividend aristocrat and has been raising its dividends for 51 years consecutively. The most recent dividend increase was 7.2% in February 2009.
- It has a product portfolio of low risk gas and electric utility business. On the other hand, it also has high risk unregulated wholesale and retail energy marketing services.
- The corporation has decided to sell its unregulated part of the business. It appears that TEG’s foray into unregulated business has not yielded any worthwhile result. Decision to sell indicates management’s realization that it does not have any potential within its portfolio. It is likely that management’s focus and resource allocation to unregulated business is one of the reasons that revenue, operating cash flow, and net income show lack of consistency.
- The stocks risk-to-dividend number is 2.43 (high category) and at the same time, dividend cash flow is less than 2.0 times the MMA income based its average dividend growth of 3.2%. The dividend payout factor for last two years has been at 100%. The recent announcement of dividend growth brings year 2009 dividend up to $2.68. This is intriguing because management has forecasted 2009 earnings in the range of $2.51 to $2.66. This will be third year in row that the payout factor will remain at 100%.
The corporation’s dividend is not support by its operating cash flow, net income, or payout factor. Therefore, I would question the sustainability of dividends for intermediate-to-long term. I will not add any new position until there is some clarity on management’s plan on how the dividends will be supported for current year and beyond. Having said this, I may or may not continue to hold my existing long position in TEG.
Full Disclosure: At the time of this writing, long on TEG.