Published September 22nd, 2016 by Eli Inkrot
Utilities have long been the quintessential example of “stodgy” or slow growing, but inherent in this business model is a good deal of consistency as well.
Among companies with enviable dividend track records, it’d be fair to suggest that Indiana-based energy holding company Vectren (VVC) is among the most revered; having not only paid but also increased its dividends… for the last 56 years. There’s something to be said for consistency.
The company’s long dividend streak makes it a Dividend King; a select group of stocks with 50+ years of rising dividends. You can see all the Dividend Kings here.
Here’s a breakdown of the different businesses that Vectren operates in:
Source: Vectren, AGA Financial Forum, Slide 6
The vast majority (~80%) of the company’s earnings are from the utility side. Further, those profits are split roughly fifty-fifty between gas and electric. By 2020 the company expects this ratio to tend toward gas comprising 65% of earnings and electric to be closer to 35%.
The company describes its utility side as “delivering gas or electric to nearly one million customers in adjoining territories that cover nearly two-thirds of Indiana and about 20% of Ohio.” Here’s what that looks like geographically:
Source: Vectren, AGA Financial Forum, Slide 13
The non-utility side operates all around the country, but as mentioned above, this is not presently a large aspect of the business.
On August 3rd of 2016, Vectren reported second quarter results. Overall total net income for the quarter was $32.3 million, or $0.39 per share, compared to $35.8 million or $0.43 per share in the previous prior year period. The utility group actually saw an increase of 7.8% in earnings, but the non-utility group dragged down the total results.
For the six months ending June 30th, 2016, Vectren reported net income of $80.6 million ($0.97 per share) as compared to $92.8 million ($1.12 per share) in the prior year period. The utility portion of the business was flat year-over-year, but the non-utility segment once again pulled down the overall results.
The company also reiterated its consolidated earnings guidance for 2016. Vectren anticipates per share earnings to be in the $2.45 to $2.55 range for the year, with the utility group providing $2.05 to $2.10 of that amount. Interestingly, the utility group guidance was slightly increased and the non-utility group slightly decreased, resulting in an unchanged total expectation as compared to the previous guidance.
Also on August 3rd, Vectren declared a $0.40 quarterly common dividend. This marks the 56th straight year of this company and its predecessor firms increasing its payout and the fourth straight payment at this level.
Competitive Advantage & Recession Performance
It’s not hard to think about a competitive advantage for a well-established utility. The business is often quite literally a monopoly, generating an essential for everyday living. Of course the downside is generally the lack of potential growth as a consequence of regulation. It’s a trade off, but you do have a good deal of consistency as a result.
Here’s a look at how the compared fared leading up to, during and after the most recent recession:
- 2007 earnings-per-share = $1.83
- 2008 earnings-per-share = $1.63
- 2009 earnings-per-share = $1.79
- 2010 earnings-per-share = $1.65
- 2011 earnings-per-share = $1.73
- 2012 earnings-per-share = $1.94
You can see that utilities are not recession-proof. Still, there are three basic notions that come into pay.
For one thing, while you did have a decrease in earnings, it was only a decrease of about 11% at its worst. Even in the worst of times, the vast majority of people still pay their electric bill.
The second thing to note is that the dividend was still increasing during this time. The payout ratio got all the way up to 80% in 2008, but the dividend was still holding strong.
Finally, we can see the “snap back” effect take place, as earnings eventually recovered. Indeed, the company is now earning well north of $2 per share annually.
Here’s a look at the dividend and earnings growth rates over the 2006 through 2015 period:
- Earnings-per-share have grown at an average compound rate of 5.8% per annum.
- Dividends per share have grown at an average compound rate of 2.5% per annum.
Incidentally, this also means that the payout ratio has been declining a bit over the years. Indeed, you don’t have to take my word for it. Here’s a look at the per share earnings, dividends and payout ratio for Vectren from 2010 until today:
Source: Vectren, AGA Financial Forum, Slide 10
You can see that while the dividend has been increasing, earnings-per-share have been growing at a faster rate. Five to six percent annually is not a blistering pace, but it is reasonably solid for a utility. Moreover, with a payout ratio held in check, future dividend growth becomes easier to formulate.
Analysts are presently anticipating intermediate-term business growth for the company to be in the 5% to 9% range. Given the above information (a historical rate in the 5% to 6% range) and the industry that we’re dealing with, you might anticipate something on the lower end of this range.
Valuation & Total Return
Here’s a look at how Vectren is thinking about its financial targets:
Source: Vectren, AGA Financial Forum, Slide 7
This is an interesting table in my view; with three distinct levers of control. The first lever is deciding how much cash to allocate toward dividends. We’ve seen that the payout ratios the company is targeting have more or less come in line recently. This is something the company has strong control over.
The next aspect is projected earnings growth; which is also in line with what analysts are anticipating. To be sure Vectren has a good amount of say here; however, not to the same degree as the payout ratio. Things can and do happen, leaving the growth rate a bit murkier.
Finally we can approach the top of the table – shareholder return. This is a nice anticipation, but in my view is somewhat out of the hands of the managers. Even if the firm grows exactly as it anticipates, there’s no mechanism that requires shares to move in lock step with this performance. Business results and shareholder returns are often two separate notions.
In the case of Vectren, the tendency for shareholders to underperform rather than outperform the business appears like a greater probability. Over the past decade shares of Vectren have traded hands at an average earnings multiple of about 16. In the past decade this multiple was still around 16, and only in the last five years or so has the average approached 17.
Based on a share price around $50 and anticipated earnings around $2.50, shares of Vectren are now trading at 20 times expected earnings – notably well above what has previously been normal. Naturally this could continue, but a prudent view might suspect that it could revert back as well.
Should both per share earnings and dividends growth by say 5% annually for Vectren, you might anticipate collecting ~$9 or so in cash dividends and see a future earnings-per-share number of about $3.20. With a future multiple of 16, this would equate to a share price of about $51 (basically where we sit today) and a total value of roughly $60. In turn, this would translate to an annualized compound gain of about 3.8% per annum.
Vectren may very well grow at 5% to 7% annually and pay out a near 4% dividend. Yet this does not automatically translate to investors receiving 9% to 11% gains. You also have to consider how the valuation might interact with the equation. In the case of Vectren, lagging rather than leading shareholder gains could very well be the case.
In short, Vectren has put together an enviable record of generating solid profits and paying out an increasing dividend. The consistency has been impressive – even for a utility. Moreover, the growth rate has actually been reasonably solid as well and this is expected to continue over the intermediate-term.
However, these items alone do not necessitate that it must be a solid investment. As a result of a much higher valuation (going from 15 times earnings in 2012 to 20 times today) a lot of the valuation proposition has faded away. Because of this, the company does not rank particularly well using The 8 Rules of Dividend Investing.