For CenterPoint Energy Inc (CNP, Financial), an electric distribution and transmission utility in Houston, Texas, things have been looking rosy as of late. Investing in the midstream space where CenterPoint operates provides exposure to a low risk, yet steadily growing earnings profile compared to higher risk peers upstream and downstream where large fluctuations will undoubtedly have an adverse impact. CenterPoint stands out as a particularly strong dividend play going forward for the following reasons: 1) superior growth prospects relative to valuation (1.12x P/Sales compared to 1.75x for America Electric Power [AEP] and 1.56x for Xcel Energy [XEL]) 2) Dividend growth rate guided at 8-10% while maintaining a steady capex ramp up, indicating the willingness of management to reward shareholders 3) Higher capital spending at ~$1.4 billion /year in 2014-2015 and $1.1-$1.2 billion/year in 2016-2018 should drive further earnings growth and 4) distributions from its 55% LP stake and 40% GP stake in Enable Midstream Partners (ENBL, Financial).
How does CenterPoint make its money?
CenterPoint Energy is an electric transmission and distribution utility that provides service to over 2 million customers in the Texas Gulf Coast region (including the city of Houston). CenterPoint Energy operates through two primary subsidiaries (CenterPoint Energy Houston Electric and CenterPoint Energy Resources Corp). CenterPoint Energy Houston Electric (CEHE) is an electric transmission and distribution utility that provides service to over 2 million customers in the Texas Gulf Coast region (including the city of Houston). CenterPoint Energy Resources Corp. (CERC) provides natural gas distribution service to 3.2 million customers in 6 states (Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma and Texas). CERC also operates natural gas pipelines and gas gathering systems. CNP's three distinct businesses (electric utility poles and wires, gas distribution, and LP and GP stake in Enable Midstream) are growing at or above peer averages and at lower risk. CNP is the fifth-largest local distribution company (LDC) in the US with 3.3 million customers in 6 states and 30,000 average annual customer growth or 1% on an annualized basis. Texas (38% of operating income), Minnesota (35% of operating income), and Arkansas (18% of operating income) mark the largest operational regions.
Why CenterPoint?
CNP has enjoyed 2% CAGR customer growth versus 0.84% nationally, supporting management’s continued upbeat tone on the company prospects. A strong Texas and Houston-area economy (5.5% GDP growth expected versus 2.2% in the U.S.) with 2% annual population growth expected over the next 25 years should also shore up earnings, going forward for CNP. Consolidated utility earnings growth, despite its lower risk profile, has been guided at an attractive 4-6% depending on timely rate recovery and higher capital investment on projects such as the Houston transmission import project. Valuations on a Price/Sales basis are currently cheap at 1.12x P/Sales compared to 1.75x for America Electric Power and 1.56x for Xcel Energy. Additionally, CNP is trading in line with peers on a P/E basis despite offering a higher dividend yield.
According to the most recent quarterly earnings report, management remains firm in guiding an 8-10% dividend growth rate over the next three years following a 14% boost to the dividend in 2014. This base growth rate of 8-10% is expected over the next 5 years backed by strong operating cash flow and its strong balance sheet. Such lucrative dividend offerings is certainly well above expectations for MLPs in general but it should be noted that CNP's risk profile is lower as it derives a significant portion of its income from the utilities space.
Also CNP’s continued ramp-up in capital spending over 2013-2014 is a key visible driver of steady earnings growth in the near to medium term, as the company transitions its midstream assets to the recently announced MLP.
Despite the capex ramp, it should be noted that 8-10% dividend growth is still expected by management over the 2015-2017 time frame following the 14% increase in January of 2014 versus 4.1% average dividend growth rate from 2010-2013. Management has clarified that dividend policy will be based on 60-70% of recurring utility earnings and 90-100% of after tax cash distributions received from ENP. ENP distributions will not be used to finance utility operations and will be returned to shareholders instead. Since the ENP IPO road show, ENP received an additional 500,000 in acreage dedications mostly in the South Central Oklahoma Oil Province (SCOOP) which represents a 10% increase to the 4.7mm acres dedicated as of the IPO. Management now expects a large diameter gas pipeline will be required in the SCOOP which could offer internal rate of returns (IRRs) as high as 50%+.
Rumor mill
Bloomberg News reported in September that CNP has agreed to participate in a bid alongside Berkshire Hathaway (BRK.A, Financial) and Hunt Consolidated for Energy Future Holding Co.'s share of Oncor. After filing for bankruptcy in April, Energy Future Holdings decided to commence the bidding process for its subsidiary. The company, which went private in 2007, had planned to divest its stake in Oncor as part of the bankruptcy. NextEra Energy (NEE, Financial) was also named as a potential suitor. CNP has not commented on this yet.
What could go wrong?
Risks to CenterPoint as a dividend play include a significant and sustained drop in U.S. oil, natural gas and NGL prices and/or production. If prices continue their recent freefall, CNP’s earnings derived from ENP could be adversely impacted. CNP’s utility businesses could also be indirectly impacted by a weaker Texas economy. Due to CNP’s concentration in Texas and the Midwest, a prolonged macroeconomic downturn could negatively impact CNP’s utility operations. Rising interest rates would likely put pressure on utility valuation multiples and would erode the relative value of CNP’s dividend.
Final word
Overall, CenterPoint should continue being a star performer despite the recent pullback in commodity prices. Key catalysts for CenterPoint, namely its strong growth prospects relative to peers, strong track record of dividends, its resilience in light of fluctuating oil prices and potentially lucrative returns from its stake in Enable Midstream Partners will likely drive higher earnings and crucially, superior dividends for shareholders. Yet, investors should remain wary of potential risks such as a further drop in commodities prices, potential macroeconomic downturns as well as interest rate uncertainty.
