Is There Any Gold In Those Hills?

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I'm not referring to the precious metal – the new gold is energy. Black Hills Corp.  (NYSE: BKH  ) is based in Rapid City, South Dakota, in the middle of a pretty big natural gas and oil boom that spans the midwest U.S. The company is in the same region as Berkshire Hathaway's Midamerican Energy unit, and is criss-crossed by Union Pacific (NYSE: UNP  ) and Berkshire's Burlington Santa Fe North railroads. Not only is the company a traditional wires and pipes utility, but it also generates electricity, and explores and produces natural gas, oil, and coal. Is this combination enough to ensure dividend growth for investors?

One way to answer this question is to look at how Black Hills creates value.

First at the meter
Let's start at the meter end of the energy value chain. Black Hills serves electric and gas utility customers in Colorado, Iowa, Kansas, Montana, Nebraska, South Dakota, and Wyoming. To help serve these customers the company owns interests in power generation it sells to utility affiliates under long-term contracts.

Ownership and control of generation helps Black Hills rank high in system availability across the U.S. It also earned top performance quartiles in the American Gas Association's benchmarking. High marks for reliability help to ensure two things: secure electric and gas rates and a steady stream of customers who sign up for energy services.

Black Hills grew its electric and gas utility rate base by nearly 8.7% per year over the past three years. The regions Black Hills serves are growing with the oil and gas boom. As an example South Dakota boasts the highest personal income growth rate in the nation at 8.6% versus the U.S. at 3.6%. Natural resource, mining, construction, trade, transportation, and utilities employment are all trending upward along with population.

A growing rate base and good reliability to maintain customer satisfaction are recipes for profitable rate base margins. These margins earn over three-quarters of the total bottom line.

Let's move upstream
Further upstream the company owns diversified operating interests in the Powder River, San Juan, and Piceance Basin plays, along with other non-operating interests scattered in North Dakota and Montana (including Bakken shale), California, North Dakota, Oklahoma, and Wyoming. These interests amount to over 80-billion-cubic-feet-equivalent (Bcfe) of reserves roughly split between 70% natural gas, and 30% oil.

Black Hills can pump from its wells for decades to come. Upstream non-regulated businesses generated about a quarter of the 2013 bottom line and is the fastest growing business segment.

Now for a view of the bottom line
Black Hills just reported a net profit margin of 8.54%, higher than its sector.The company generates a quarter of its earnings from fast growing non-regulated businesses and the rest from its regulated utilities. Almost a fifth of its earnings is directly exposed to oil and gas exploration and production businesses. The volatility of that exposure can help Black Hills grow earnings.

Black Hills keeps growing its dividend and has done so for 44 consecutive years. Investors earn about a 2.7% dividend yield. At the same time Moody's upgraded the company's corporate credit rating to Baa1 from Baa2. This is in light of the company's recent unsecured debt offering. Black Hills also has solid coverage to pay its bills and cover any surprise cash drawdowns. It has less debt relative to equity and great ability to pay debt interest out of earnings than its sector.

Black Hills is growing equity at a nearly 5% rate while earning almost a 3% dividend yield. Black Hills stock price tracks the market on average. But the S&P 500 market is only generating a 1.90% yield with 4% earnings growth.

It looks like Black Hills is beating the market. If customers continue to grow with the oil and gas boom, if the company can maintain its strong balance sheet, and can continue to reap returns from its non-regulated oil and gas businesses, I believe Black Hills may be able to keep earnings growing. Yes, there is gold in those hills.


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Bill Foote

I scour physical and financial commodities globally to uncover the political, economic and financial reasons for value creation and destruction globally.

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9/4/2015 10:17 AM
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