Two Picks for Utility Investors: Ameren and NiSource

08/02/2019 5:00 am EST

Focus: UTILITIES

Gary Hovis

Vice President & Director of Utility Research: Utilities (Electri, Argus Research Corporation

Although analyst Gary Hovis of Argus Research has an underweight rating on the utility sector, he does believe the sector should still account for about 2% of diversified portfolios. Here he reviews two utility stocks that earn his buy rating.

St. Louis-based Ameren Corp. (AEE) serves approximately 2.4 million electric customers and 900,000 natural gas customers through its Ameren Missouri and Ameren Illinois rate-regulated subsidiaries.

We favor the company’s strong balance sheet, expanding rate base and generally positive relations with regulators, and we continue to expect Ameren to deliver average annual earnings growth of 5% over the next five years.

Strong cost controls are in place and management has a track record of executing across the board. We also believe that the company benefits from balanced regulation in its Missouri and Illinois service territories.

Management believes that the company has adequate liquidity through its current cash balances, cash from operations, and credit facility to meet all anticipated cash requirements through 2020.

The company also has a growing network of transmission assets, which have the potential to earn a higher return on equity than utilities with generation and distribution assets.

The company’s operating utilities, Ameren Missouri and Ameren Illinois, are well managed with growing cash flow. Moreover, the company continues to benefit from its geographic diversity and a growing customer base.

Ameren pays a dividend. During 4Q18, the board boosted the dividend 3.7% to an annualized $1.90. We look for annual dividend hikes of 4%-5% going forward. Our dividend estimates are $1.96 for 2019 and for 2020, we are looking at $2.02.

We think the AEE shares are attractively valued at current prices near $76. Over the past 52 weeks, AEE shares have traded between $61 and $77. From a technical standpoint, the shares have been in a bullish pattern of higher highs and higher lows that dates to June 2015.

On the fundamentals, the shares currently trade at 22-times our 2020 EPS estimate of $3.50, above the company’s five-year historical average of 14.7-times but below the high end of the industry range of 15-to 25-times.

We think a premium to the industry is deserved, given the company’s consistent operating and market performance. These factors, in our opinion, should combine to generate total annual returns for shareholders, including dividends, of 8%-10%, at a low beta. We see the AEE shares as a core Utility holding in a diversified portfolio.

NiSource Inc. (NI) is an energy holding company whose subsidiaries are fully regulated natural gas and electric utility companies serving approximately 4.0 million customers in seven states. NiSource is one of the nation’s largest natural gas distribution companies, as measured by number of customers.

NiSource recently completed a corporate restructuring that resulted in the spinoff of its pipeline group subsidiary. The balance sheet appears stable and able to support the current dividend, which yields about 2.8%.

Management is committed to electric and gas service expansion strategies in the company’s regulated service territories, and to the expansion of its gas transmission and storage business.

We think the company’s platform for a return to growth is solid, and we are confident in management’s ability to provide shareholders with increased value over the long term.

NiSource continues to rely on its utility infrastructure programs for earnings and dividend growth. The company’s regulated gas and electric segments will primarily invest in pipelines and in transmission and distribution modernization programs, and should benefit from favorable regulation.

The company expects adjusted operating earnings in 2019 of $1.27-$1.33 and capital investments of $1.6-$1.7 billion. In all, management expects the company to post operating earnings growth of 5%-7% annually from 2019-2022 resulting in total annual returns for shareholders of 6%-7%.

NiSource could also become a buyout target, as larger utilities and private equity firms have purchased smaller utilities because of their stable earnings growth and above-average dividend yields. Even so, we think the possibility of a buyout is largely priced into the NI shares.

The dividend yield of 2.75% is slightly above the industry average of 2.6%. We are establishing a 12-month target price of $32 which implies a potential return including the dividend of 12.6% from current levels.

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