JotCast | 8/23/21 Conrad's Utility Investor Live Chat

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8/23/21 Conrad's Utility Investor Live Chat

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Roger Conrad

2:53

So long as that's the case, my forecast would be for a rise in benchmark interest rates, the 10-year Treasury being the most important to watch and the 1.8% level for the yield as a key resistance point. I would expect that level to hold, as the corresponding impact on other borrowing costs would likely at least a good deal of the inflationary pressures we're now seeing. As for inflation, we're definitely seeing it for some items where supply chains have been disrupted over the past year like semiconductors, certain metals that are key to development of components needed for the energy transition like solar panels and batteries, certain commodities and services impacted by protectionist policies of the Biden Administration that were adopted from the Trump Administration and basically any businesses that's depended on lower wage labor, or alternatively specialized labor needed for major projects.

2:57

I generally come down on the side of those who see these as mostly temporary pressures, given the ferocious global competition in multiple industries, the fact that so much capital can now be deployed so cheaply to fill gaps in supply and the ongoing data revolution that's allowed companies, governments and individuals to cut costs and improve efficiencies on an unprecedented scale. But I do think it's absolutely essential for investors to monitor how businesses of companies they own are being affected by inflation pressures. So far, there's minimal impact on our coverage universe based on Q2 numbers and guidance. But this is a work in progress and very much a part of my recommendations process.

2:59

I do think the strength we're seeing in the US dollar recently against the Euro, Canadian dollar etc is more of a reaction to concerns about the global economy (the dollar is a safe haven currency) than a long-term trend. That's one reason I continue to recommend stocks that pay dividends and are primarily priced in these currencies.

3:04

Finally, regards taxes, there are a lot of them proposed in the $3.5 trillion reconciliation package that the president and Democratic Congressional leaders are pushing--but at this point, the vast majority of them appear to be very much negotiable, since every since Democrat will need to vote yes in the Senate for it to pass and several senators not hiding their discomfort with the size of the package. From what I can see, there are a lot more goodies in this proposal so far than tax increases, which could be expansionary for the economy in a way we've never seen before. The devil is in the details clearly. But I would also say that any taxes passed now will basically be on the ballot next year. And given how much is up in the air, it really doesn't make any sense for investors to try to anticipate. Encouragingly, I don't see a lot to threaten tax status of REITs or MLPs--so both could get a lift on a hike in corporate or individual tax rates.

3:05

In any case, I think our key task here is still to find stocks of companies with great businesses that trade at good entry point. That's what does best for income investors in any environment for interest rates, economic growth, inflation, the dollar or taxes. Thanks again for the question.

Robert P.

3:12

Hi Roger, hope all is well and thank you for Conrad's Utility Investor's Live Chat.
My question involves utilities existence in the future.
When wind, solar, and renewable energy is the main source of energy, it is suggested that there will be no need for the utility company. Is there any promise or truth to this.

For example: Refineries, warehouses, manufacturing and large customers, even municipalities creating their own energy grid, you hear mention of not using utility companies for the source?
Besides the utilities, will power generators, AES, Atlantica, Clearway, etc. be more in demand. Your opinions on this evolution, greatly appreciated. What should we be thinking about today for the future of this evolution?

Roger Conrad

3:12

Hi Robert. I've been researching and recommending utility stocks since the late 1980s, and I tell you this has been a media topic periodically for all of that time. In fact, a couple years before I started working in the investment advisory business, Business Week ran a story with the cover headline "Are Utilities Obsolete." And since the publication date, a portfolio reinvesting dividends in the Dow Jones Utility Average would be up about 7,000%.

In the 1980s, the big issue was cost overruns on new power plants, namely nuclear facilities. In the 1990s, it was first "cogeneration" of industrial companies producing their own power and then deregulation passed in many states that allowed competition for the first time in retail and generation, with regulated utilities owning just transmission and distribution. In the latter '00s and '10s, it became about distributed generation, mainly rooftop solar adoption and then microgrids where communities could cut the cord by building their own networks.

Roger Conrad

3:17

Each time, utilities were able to adapt to the changed environment and in fact become arguably more essential as going concerns. In the case of cost overruns, they took their medicine, cutting dividends but later putting cash flow surpluses to work rebuilding balance sheets, restoring payouts and investing in growth. In the case of cogeneration, industrial concerns soon realized they really weren't saving much and in fact the spike in natural gas prices in the '00s proved ruinous to many companies. That also proved true of independent power producers that were supposed to take over generation, with Calpine going bankrupt following the likes of Enron, Dynegy and others. Now it's distributed energy/solar that utilities have adapted to. Companies like Edison International have a real opportunity to invest in utility grids to absorb more rooftop as well as storage, which they're augmenting with EV charging stations.

3:22

As for renewable generation, utility NextEra Energy is by far the largest producer of wind and solar energy in the US. A good bit of that now is at the regulated utility level, where it's more than 40% already toward its goal of installing 30 mil solar panels in South Florida by 2030. Dominion Energy has the largest regulated utility rate base renewable energy buildout in the country. There's plenty of opportunity for AES (also a regulated utility), Clearway, Atlantica and others to build and operate generation under long-term contracts. But their primary customers are regulated utilities, either as direct purchasers are by use of their grids to get energy to customers. Utilities are also the leaders in direct contracts with corporations, which would be warehouses etc.

3:25

It's certainly possible for municipalities, businesses etc to build their own power systems and cut the cord to the utilities. What we've seen though is very few have done so over the years because it's a good deal more expensive and time consuming to manage your own energy system. And so long as the utility companies are giving them the clean, affordable energy they want, there's no incentive to do something different. That also goes for potential municipalization, which most recently stalled out in Colorado with the deal between Xcel Energy and the City of Boulder. And most cities have much bigger financial problems than to take over or try to replace utilities.

3:26

I've already extended this answer a great deal, which is deserved because this is a great question. But the bottom line is when it comes to replacing utilities, I'll believe it when I see it. And right now, the energy transition we're seeing globally appears to be doing the exact opposite.

Jack D

3:35

Current thinking on suburban propane , and air products as a hydrogen play

Roger Conrad

3:35

Hi Jack. I''ve rated Suburban Propane Partners a buy up to 15 in the Utility Report Card for a while for two main reasons. First, recent results and the 8.3% distribution increase announced in late July indicate to me that the combination of the 50% distribution cut in July 2020 and scaling up through acquisitions has allowed the company to balance its financial policies, with the result the yield is now sustainable the next several years. Second, it's very much a potential takeover target with a market cap south of $1 bil, and Superior Plus Corp (TSX: SPB, OTC: SUUIF) still a prime candidate. I thought the FYQ3 results were solid (end June 30) as well.

Air Products and Chemicals definitely looks like a potential player in any future green hydrogen market, given its leading position in specialty gases. It also appears to have a pole position for a similar future market in China, which appears to be pushing hydrogen hard as a way to reduce its emissions challenges. The company is actually participating in

Roger Conrad

3:40

Shandong's bus and truck fuel demonstration project "Hydrogen into Ten Thousand Homes." At this point, the company is still realizing most of its earnings from other sources. But this is a good example of a company that is already making money and appears to be tapped into a powerful long-term growth trend. I haven't added it as yet officially to one of our coverage universes and its worth pointing out the stock isn't particularly cheap at 26 times next 12 months earnings--as well as the fact that shares have been somewhat volatile over the years. But there is some appeal of long-term investors here, particularly given it's actually down about -6% over the last 12 months. Thanks for the suggestion.

Frank

3:46

Hi Roger,

I read your opinion on AGL with great interest. Yet, the stock looks like a leftover piñata at a birthday party. Do you feel the dividend will hold or could find its way to .50 annually so as to help the recovery. Current level seems unsustainable. Thanks for all your great work.

Roger Conrad

3:46

I don't think you should count on AGL Energy paying the same level of dividend the next 12 months as it did the previous 12. I had hoped that view came through clearly in the update and I greatly apologize if it was less so. Basically, management is saying they'll pay out 70% of net profit after tax, which is from guidance will be about 20% lower. That's still a fairly generous level of payout. And I note that management for whatever other faults has been accurate with guidance--in fact, the previous fiscal year results were actually a little better than expected. But the coming year's dividend will almost surely be about 20-30% lower than this year's.

That said, the real issue for AGL is if it can successfully spin off its coal and natural gas power generation from the rest of the company, and if it can what the two resulting halves will wind up being worth. My view and the reason for upgrading to buy is that I think investors are pricing in far too much risk and not enough upside from what is after all

Roger Conrad

3:48

still Australia's leading generator of electricity from fossil fuels as well as renewable energy, the country's leading energy retailer that's now successfully selling multiple services including communications in bundles, and the country's leading deployer of distributed energy systems including rooftop solar and storage.

3:50

I certainly wouldn't call this a low risk stock. And I think there's potential for more downside as it works out the spinoff. But I do think the company has reached a low point as a business and there are multiple catalysts for a major recovery in the stock--including a possible Australian government policy that makes electric companies whole to accelerate the energy transition as we've seen in Germany and more recently Alberta province in Canada. It's a buy for patient long-term risk tolerant investors at a price of 7 or lower--for all its blemishes now.

Don C.

3:57

Roger--how serious do you feel inflation is in the US going forward? What utilities do you feel will be affected the least by it if prices continue to rise far above the Fed's 2% target?

Thanks for all that you do. You are a voice of sanity among the constant hype of the CNBC talking heads.

Roger Conrad

3:57

Thanks Don. I appreciate the complement. I gave a pretty long winded answer to a question on inflation earlier in the chat and won't repeat what I said then. The gist of it is that we need to watch carefully the actual costs of companies including utilities, and how they're being affected by the pressures that are clearly affecting some businesses. I mentioned companies dependent on low wage labor. That generally doesn't apply to utility jobs and pressure on specialized labor cost for big projects such as Southern Company's Vogtle appears to be much less of an issue to date than absenteeism due to Covid.

Companies building major renewable energy projects were frequently asked about supply chain disruption and higher components prices during Q2 conference calls. I did not see much evidence of higher costs biting earnings in numbers or guidance for regulated utilities or even developers like Clearway Energy. But this is definitely an issue I'll be watching in future results.

The bottom line for utilities

Roger Conrad

3:59

is always whether or not regulators will allow them to pass along costs in rates. And so far at least, that has not emerged as a real issue for company earnings. California, for example, earlier this month announced an amicable rate deal for Edison International that appears to allow solid returns on new grid investments. And it also helps a great deal that utilities are undergoing a data revolution that's producing continual improvements in productivity.

4:01

I do think there's a risk that inflation could go a bit higher than the Federal Reserve and other Central Banks are letting on. In fact, I think it's clear they're prepared to allow something well above 2% so long as it doesn't start to create stagflation. It's a dangerous game for sure. But I think they're a lot more worried about the pandemic triggering an economic relapse at this point.

4:04

Again, the pace of inflation we've seen so far is highly uneven, And I think our focus has to be on the individual companies we own--and being sure they aren't the ones getting really whacked. But at this point, utilities as a group don't appear to be really affected from an earnings standpoint. And keep in mind that regulated utilities pass through fuel costs in rates with no earnings impact.

David O

4:08

Southern Company, SO. Should I add this to my conservative income portfolio with D, AEP, DUK, EIX, NEE? The nuclear stuff with delays and overruns scares me. Many say that SO, will be able to handle that without too much trouble. SO has an incredibly reliable track record. Should I buy?

Roger Conrad

4:08

As I indicated answering an earlier question on Southern Company, I really think successful completion of hot functional testing at the Vogtle facility was a major milestone--and it's why the shares have moved to the mid-to-high 60s this month. They still have to fuel it and start it up. But it looks like the risk of massive new delays and costs has fallen a lot since the beginning of the summer, and that there is proof of concept at the facility. I'm not likely to raise my buy target past 65 until Unit 3 starts up successfully. But I do think the risk has dropped a lot for purchases under that number.

I like the other stocks you hold--so long as they're also purchased under my highest recommended entry points.

Roy W.

4:16

There's a lot of discussion of moving toward universal broadband, including your August issue. Virginia's governor is even touting his plan to spend big bucks taking wires to remote places. But neither the governor nor your newsletter is talking about Starlink, which has over a thousand satellites in low earth orbit and is currently providing high speed broadband to customers in remote locations. Am I missing an obvious drawback, or should we consider the possibility that low altitude satellites would be be a cost effective alternative to wiring up remote areas?

Roger Conrad

4:16

Hi Roy. Maybe I'm looking at the wrong company. But Starlink appears to be a private company now owned by Raven Industries (NSDQ: RAVN), which has a very diverse product and service line directed at agricultural and targeted industrial customers. If that's incorrect, please educate me.

I will say, however, that satellite communications overall has been losing ground pretty rapidly in the consumer and commercial markets, as demonstrated by the relentless customer defections at soon-to-be divested AT&T (NYSE: T) unit DirecTV and DISH Network (NSDQ: DISH). The problem they have is fiber broadband and even 4G wi-fi where available is simply a lot faster. That's not to say a lot of people don't have a satellite dish--in fact, I've found it to be the only game in town in many rural Virginia places I like to visit. But at least at this point, the alternatives are faster and ever-more competitive as they become cheaper.

Roger Conrad

4:18

On the broader question of broadband spending, the track record of direct government spending to create efficient networks is pretty dismal in my view. That's why the Senate infrastructure bill as I read it will rely on what amounts to subsidy to the private sector. The biggest beneficiaries are going to be the companies that were already doing the job, which makes sense as they already know where to spend it.

Mr. G

4:25

Any advice on Dream Office Real Estate Trust (DRETF) owned at $30.76 and Artis Real estate Invest. Trust (ARESF) owned at $9.91, which you had recommended back when both of us were much younger?

Roger Conrad

4:25

Yes it's been a slog with Artis REIT, which I started tracking in my old Canadian Edge advisory at my former publisher in the early '00s. I actually cover it now as a recommendation in my REIT Sheet advisory, along with Dream Office REIT and several other Canadian REITs in a total universe of about 80 names. Artis is a somewhat different animal these days, as management has elected to reorient it toward being an investor rather than property operator. It's already made several aggressive and I think effective moves in that direction, including the sale of the industrial portfolio. And the result has been two boosts in the monthly payout so far this year. I think it's a solid income investment at USD10 or lower. As for Dream Office (OTC: DRETF), I greatly prefer Dream Industrial REIT (OTC: DREUF) in the family for its investment in the red hot industrial sector. But unlike many of the office REITs in the US, it appears prepared for a future of lower occupancy as more businesses elect to save money with smaller

Roger Conrad

4:26

spaces and more working from home. Q2 was solid with distributions well covered even at a low 80s percentage occupancy rate. Office property is going to be a tough segment of the market--but it's also leveraged for a lot of upside the next time pandemic pressures seem to subside. And DRETF is a low risk way to play it in my view.

Guest

4:33

how do you feel about Pinnacle west and the rate case ?

Roger Conrad

4:33

Good question. When we learned the results of last November's election for the Arizona Corporation Commission I was cautiously optimistic we'd see a continuation of the cooperative approach between the utility and regulators of recent years. I still think there are a lot of positives to the relationship, one of which being mutual support for spending on renewable energy and grid upgrades. But an administrative law judge on August 2 recommended a revenue increase of just $3.6 mil of the $169 mil requested by the utility. And if adopted in full and not offset elsewhere by management, it could knock as much as 16% off annual income.

I don't think even that would threaten the current dividend level. And the history of these cases has been the ACC takes a number between the request and the recommendation. The key issue here is work the company has done to restrict emissions at the Four Corners coal-fired power plant--which is essential to meeting surging demand in the Valley of the Sun service territory but is

Roger Conrad

4:35

controversial in the current environment. Again, I think the ACC will come down somewhere in the middle in this case. The final impact on earnings will be mitigated by cost cutting, some of the strongest customer growth in the country (2.3%) and ultimately another rate filing. And Pinnacle shares at 16.8 times expected next 12 months earnings are already pricing in a worst case--I've also held our highest recommended entry point to 80 on that basis.

4:38

If the ACC does come in with the ALJ recommendation, however, it would be a bad sign for the future and might convince me to become a lot more negative on Pinnacle going forward--given that one punitive regulatory decision is often a pretty clear warning of more to come. That's not what I expect at this point, however. And anything short of that still leaves a utility with a big rate base opportunity in renewable energy selling at a good price.

jeff

4:44

Roger, what's your opinion on DVN or PXD ?

Roger Conrad

4:44

Hi Jeff. That's really more of an Energy and Income Advisor question. And FYI, my partner Elliott and I will be holding our regular monthly EIA chat on August 31, starting at 2 pm for all members. I hope you'll join us. But the short answer is we greatly prefer Pioneer Natural Resources (NYSE: PXD), which is a member of the model portfolio. The company was basically the first major independent to build a positions in the Permian Basin of west Texas and it's continued to use it well to build profitability as other players have come and gone in recent years. As an anecdote, Elliott and I attended an industry conference in the Permian a few years ago and one of our key takeaways is how current and former Pioneer people really dominated the agenda. I think they wisely played it conservative during the last decade's boom and have as a result was able to make key acquisitions at low prices for DoublePoint Energy and Parsley to fill out its holdings. Great stock for betting on an upturn in the energy cycle.

jeff

4:44

Roger are PXD and DVN a buy at today's prices?

Roger Conrad

4:44

Both look cheap now but we favor Pioneer.

Terry

4:51

I am interested in your thoughts about EXC with the deadline for closing Byron and Dresden plants and the IL government still not getting off the dime to approve a bailout.

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