Wed. Mar. 3, 2010

Increasing Dividend Yield Part I: Utilities *

This is the first installment in a multi-part series that looks at various options used by income investors to boost their yield while waiting for dividend growth to lift their portfolio’s overall yield-on-cost. This week we are looking at Utilities – those investments long considered as a safe harbor for “orphans and widows.”

What’s the difference between a Ponzi scheme and a utility company? Before I answer that question, let’s look at what a Ponzi scheme is.  Wikipedia defines it as:

A  fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.

In effect, a Ponzi scheme pays yesterday’s investors with money from today’s investors. It works great until there aren’t enough new investors to pay the old investors. In a similar manner, most utility companies rely on new capital either in the form of debt or equity to fund investment and to pay dividends. Consider the following:

Atmos Energy Corp. (ATO) – Yield: 4.88%
Shares Outstanding: 2000 31m; 2009 92m
Long-Term Debt: 2000 363.2m; 2009 2,159.5m
Years of Negative Free Cash Flow: 5 of 10

Black Hills Corp. (BKH) – Yield: 5.10%
Shares Outstanding: 2000 22m; 2009 38m
Long-Term Debt: 1999 160.7m; 2008 719.2m
Years of Negative Free Cash Flow: 7 of 10

Connecticut Water Service Inc. (CTWS) – Yield: 4.01%
Shares Outstanding: 2000 7m; 2009 8m
Long-Term Debt: 1999 65.4m; 2008 92.2m
Years of Negative Free Cash Flow: 5 of 10

California Water Service Group (CWT) – Yield: 3.29%
Shares Outstanding: 2000 15m; 2009 20m
Long-Term Debt: 1999 156.6m; 2008 373.5m
Years of Negative Free Cash Flow: 10 of 10

Consolidated Edison, Inc. (ED) – Yield: 5.52%
Shares Outstanding: 2000 212m; 2009 276m
Long-Term Debt: 2000 5,415.4m; 2009 9,854.0m
Years of Negative Free Cash Flow: 6 of 10

MGE Energy Inc. (MGEE) – Yield: 4.40%
Shares Outstanding: 2000 16m; 2008 22m
Long-Term Debt: 1999 148.6m; 2008 272.5m
Years of Negative Free Cash Flow: 7 of 10

Middlesex Water Co. (MSEX) – Yield: 4.31%
Shares Outstanding: 2000 10m; 2008 13m
Long-Term Debt: 1999 82.5m; 2008 118.2m
Years of Negative Free Cash Flow: 10 of 10

Progress Energy, Inc. (PGN) – Yield: 6.48%
Shares Outstanding: 2000 157m; 2008 260m
Long-Term Debt: 1999 3028.6m; 2008 10,659.0m
Years of Negative Free Cash Flow: 5 of 10

Integrys Energy Group, Inc. (TEG) – Yield: 6.17%
Shares Outstanding: 2000 26m; 2008 76m
Long-Term Debt: 1999 634.5m; 2008 2,396.7m
Years of Negative Free Cash Flow: 10 of 10

Each of the above companies are growing their debt and shares outstanding while generating insufficient cash to fund their operating expenses, including normal capital replacements, in at least 5 of the last 10 years. For a company to consistently raise its dividends, it must generate strong cash flows sufficient to meet operating obligations and to service outstanding debt. When the day comes that these companies can not raise enough capital to fund the operating requirements, the first source of additional cash will likely come in the form of a lower or eliminated dividend.

So, back to the original question, what is the difference between a Ponzi scheme and a utility? The answer is simply disclosure. All the above information on these companies was made available via S.E.C. filings. Unlike Bernard Madoff, these companies are telling you exactly what they are doing, thus there is no intent to defraud. I own some of the companies above, but I won’t be rushing to add to increase my positions.

Caveat emptor!

Full Disclosure: Long ED, PGN, TEG. See a list of all my income holdings here.

(Photo Credit)

9 Responses to “Increasing Dividend Yield Part I: Utilities *”

  1. Viral Desai says:

    Thanks for this list. What do you think about PCG?

  2. dizzy7 says:

    That’s an interesting and important factor to consider when investing and one that is rarely mentioned. Very helpful and informative post. Thanks.

  3. Interesting article. I like the comparison between utilities and Ponzi schemes. I prefer low-debt investments myself, but that can be difficult to find among utilities.

  4. Bill66 says:

    Just wait until interest rates start rising in earnest. a.) Debt becomes more expensive, leaving even less money for dividend increases. b.) share prices shrink as utility investors start moving into bonds. … been there, seen that.

  5. Barry says:

    I agree with your point entirely. I also noticed that you are long on some of the companies mentioned. Judging that these companies are in a less than ideal situation due to the negative free cash flow would you care to comment on what you would look for as a determining factor that it is time to sell and move on. I have just found your site and really enjoy it great work!

  6. Barry: My one firm rule is to sell an income stock if it cuts its dividend. Otherwise, I will watch the companies dividend fundamentals, if they deteriorate, I will eventually sell the company. In this case TEG and PGN are well along the sell path since both failed to raise their dividends at the appointed time.

    Best Wishes,

  7. omi says:

    so what the sec does is make it legit?

  8. Omi: It makes it legal, but necessarily a good investment.

    Best Wishes,

  9. Weiwen says:

    I like Westar (WR), a regulated utility in Kansas. It has a good relationship with its regulators. I also like Exelon (EXC), but not as an income stock; its regulated ops are mediocre, but it merchant generation fleet is nuclear-powered and has a significant cost advantage over others.