How Can This Regulated Utility Continue to Find Growth?

Utility stocks feed income strategies. This is because their customer base is flat. PPL seems able to grow rate base in spite of flat customer growth. It does this through service improvements and innovative rate cases in multiple regional franchises.

Feb 12, 2014 at 2:46PM

Most electric and gas utilities are tied to the simple economics of population and income growth in their regulated franchises. A 2% growth in population usually translates into no more than 2% growth in earnings per year, at best, over a very long period of time. PPL Corporation (NYSE:PPL) seems able to break through the damper of income and population growth in the regions it serves. It does so by providing predictable, controlled, and innovative energy solutions. These are attributes that regulators trust, and PPL has enjoyed the trust of regulators in the U.K. as well as the U.S. 

Can PPL continue to grow a regulated franchise?

Rate base growth
PPL has grown its rate base by 8% per year. It does this through a combination of building demand and generation services in regions poised for further economic growth, along with fast-track relationships with regulators. This latter attribute has contributed to awards of 10.25% and 10.4% return on equity, or ROE, in Kentucky and Pennsylvania, respectively.

Through its rate cases, PPL virtually eliminates volumetric risk embedded in capital expenditures. By reducing the regulatory lag between capital and operational expenditure and recovery in rates, PPL can promise on-time cash flow to investors. They are able to earn revenues almost on a take or pay basis through the two-part tariffs negotiated with the regulatory authority. One part provides real-time recovery of capital expenditures, the other tracks electric and gas usage.

In Pennsylvania, the Act 11 Distribution System Improvement Charge, or DSIC, provides timely recovery of electric distribution capital costs. PPL was able to recover $700 in safety and reliability distribution investment over five years using this regulatory vehicle. The provision allows PPL to collect a 5% surcharge on customer bills for critical infrastructure improvements.

DSIC investment also translates into increased efficiency for customers and the growing distribution system. More efficiency and reliability induces more customer satisfaction, lower rates of adverse regulatory review, and more rapid and steadier increases in regulated ROE. A similar story holds for the Kentucky Environmental Cost Recovery, or ECR, mechanism. PPL will be able to recover over $2 billion in system capital expenditure with a 10.25% ROE.

In the U.K. PPL serves over 7.8 million electric customers. Ofgem, the U.K. regulator, has challenged utilities to cut customer rates by over 11%. PPL's Western Production Division , which runs the U.K. service areas, was awarded "fast track" status along with several demand management projects. This means a fast track to earning 2.5% of expenditures in revenues during the price control period commencing in 2015. This could translate into over $30 million per year. Again, more customer satisfaction, more efficiency, and the Ofgem performance awards to boot, leads to better margins in spite of lower rates.

Hedging to protect generation earnings
PPL has been able to decrease generation capital spending in PJM and Montana while maintaining high spark margins for nuclear, gas, and coal assets. Baseload generation is projected to be over 48 GW with intermediate and peaking load at about 8.5 GW. Over 84% of baseload capacity is generated in PJM.

PPL earns capacity revenues in PJM for generation served and transmitted. Capacity prices may be dropping by up to 11% over the next year into 2015 and are expected to contribute over 500 million in 2014 and 2015. PPL actively hedges natural gas, coal, and electricity prices to ring fence generation fuel to electricity spreads, as well as maximize capacity revenues. This will help smooth the earnings impact of commodity price volatility within a $3-$4 per mwh range.

Bottom line
PPL has over $6 billion in credit facilities. It has committed over $900 million during 2013. PPL will be repaying over $2.9 billion in debt through 2017, with most of it coming due in 2015. Cash flow through the third quarter 2013 grew 36% year on year relative to 2012. Reflected in this rate are a $1.4 billion common stock issue, a $645 million dividend payout, and a $690 million capital expenditure increase year on year over 2012. Cash flow net of the common stock issue would not have covered both the dividend and capital expenditure increase.

PPL is paying out 60% of net income at a 4.8% dividend yield. Price to cash flow comes in at a discounted 6.6x relative to an industry average of 9.2x. The discount might be due to the $1.4 billion common stock issue. Paying down debt over the next five years should improve the debt-to-equity ratio of 1.65 against peers at 1.16. Regardless of the pay-down, PPL has more than sufficient interest coverage at 3.10x, which is greater than peers at 1.60.

PPL seems safe enough. A retention rate of 40% times a ROE of 12.90% implies a potential equity growth rate of over 5%. Analysts estimate a drop in earnings of over 8%. PPL managers have their job cut out for them to beat the analysts and achieve their own equity growth potential.

More income investing ideas with The Motley Fool
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

 

Bill Foote has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers