The next selection for the newly launched Inflation-Protected Income Growth Portfolio is electric generator NV Energy (NYSE: NVE). A relatively small player in the electrical generation market, NV Energy nevertheless covers one of the most brightly lit and heavily air-conditioned cities in America, Las Vegas. NV Energy was formed through the merger of Nevada Power, Sierra Pacific Power, and Sierra Pacific Resources, and the combined company's dividend has risen every year since 2007.
Sierra Pacific had a decent dividend growth streak a few years prior to the merger, until legislation in place to facilitate electric deregulation caused it to eliminate its dividend. Though electric generation is generally considered a "widows and orphans"-type investment, this does illustrate one of the political risks in the industry, and is one of the reasons that the stock is available at a decent valuation today.
Why it's worth owning in the iPIG Portfolio
To earn a spot in the portfolio, a company has to pass a series of tests related to its dividends, its balance sheet and valuation, and how it fits from a portfolio diversification perspective.
- Payment: The company's annual dividend currently sits at $0.68 a share, a yield of about 3.7% based on Monday's closing price.
- Growth history: The company has paid higher dividends every year since restoring its dividend in 2007.
- Reason to believe the growth can continue: With a payout ratio of 51%, the company retains about half of its income to reinvest for future growth. That ratio is well below the 95% of industry giant Duke Energy (NYSE:DUK) or the currently uncovered 112% payout ratio of nuclear power titan Exelon (NASDAQ:EXC). Additionally, since NV Energy's cash flow statement indicates that its earnings are covered by cold, hard cash, there's little risk that a near-term cash crunch will derail those plans.
Balance sheet and valuation:
- Balance sheet: A debt-to-equity ratio of 1.4 indicates that the company does use debt, but reasonably, and it certainly hasn't overleveraged itself to the point where a financial hiccup would derail it.
- Valuation: By a discounted cash flow analysis, the company looks to be worth around $5.0 billion, making its recent market price of $4.4 billion look reasonable. Of course, there's some risk involved. For instance, if it becomes prohibitively expensive to bring new generation capacity online, the company could be forced to pay exorbitant charges on imported power to meet peak demands.
The previous picks for the portfolio included:
- An industrial conglomerate
- A generic-pharmaceutical powerhouse
- A provider of staple foods
- An auto parts distributor
- A safety equipment provider
- A high-tech titan
- A toy maker
...making this electric utility a reasonable fit.
What are the risks?
The majority of NV Energy's generation capacity is linked to natural gas. As long as natural gas prices stay low, the company should be able to comfortably cover its generating costs, but if gas prices once again spike as they did in 2008, margins could get squeezed. Additionally, the company does have to routinely import electricity to meet the demands of its Northern Nevada customers. If it's forced to import at an inopportune and expensive time, it could cost the company cash.
There's political risk involved, too. If Nevada ever reopens electricity deregulation discussions, the company could again be forced to cut its dividend, depending on where the legislation leads. Additionally, the stricter the EPA gets on rules surrounding electricity generation, the costlier it will be for the company to meet the demands of any growing population.
What comes next?
When the Fool's disclosure policy allows, I plan to buy NV Energy stock for the Inflation-Protected Income Growth portfolio, as long as its share price remains below $20. I expect to invest around $1,500 in the selection, giving it a 5% allocation in the portfolio, with 60% of the portfolio still remaining cash. Watch my article feed for details of the next pick, coming soon.