Tuesday, December 09, 2008

Utility Futility

The last post on wind turbine companies followed along a path well traveled by investors these days - utilities. In the current market the energy or utility sectors are a big draw for many investors who see a chance to buy water and electric dividends at deep value. A series of posts in May 2008 - May 16th, Paying Big Dividends; May 20th, In for the Long Haul; and May 23rd, More Dividends - discussed the strategy and offered a few small cap dividend payers.

Since the dramatic drop in valuations, the opportunity to buy cheap dividends is even more compelling. It is also a great way to play green tech. Home work is necessary as not all utilities are created equal either in terms of dividends or their resolve to be “green.”

Avista Corp. (AVA: NYSE) was named as a buyer or rather non-buyer of wind turbines in our last post - December 5th, Tilting at Windmills. Avista characterizes itself as an “energy company,” providing electric and natural gas services to customers in the western U.S. Avista management was quick to correct the results of our field work that suggested the company was using a line of credit to retrofit wind turbines.

Turns out Avista did decide to delay purchase of new wind turbines for a proposed wind park by two years, but the company’s hydroelectric turbines are getting the retrofit. Hydroelectric turbines are turned by water of course and that makes them “green” too.

It makes sense that Avista’s capital spending program would slow since earnings sagged in fiscal year 2007 to $0.74 per share compared to $1.49 in the previous year. Things are going better in FY08, but the September 2008 quarter was the second lowest net income in three years.

Like all utilities it is worthwhile to turn the page past the income statement and look at cash flows. As it turns out Avista’s capital spending so far this year has kept pace with 2007 when the Company invested $187 million in PP&E. However, this year investing has exceeded cash flow generated by operations.

Investors should not necessarily be alarmed by the use of cash reserves to pay for capital projects…or dividends for that matter. Avista over-spent current cash flows in 2004 and 2005 and revenue climbed in each of the three years after.

However, this year the situation is quite different. Avista started out the current year with $24 million in cash compared to the beginning of 2004 when the Company’s bank balance was a hefty $147 million. Cash at the end of September 2008 was a paltry $15 million.

Avista’s dividend yield is a compelling 4.0% at the current stock price. Yet capex spending exceeds current cash flows and the bank balance is the lowest in six years. This is not the best scenario for a dividend play as appealing as Avista’s “green” appearance might be.

Avista is among a group of thirty or so diversified energy companies - that is electric producers with other interests. It is engaged in natural gas distribution and has investments in real estate and venture capital. As dividends go, Avista does not offer the highest yield. That honor goes to NiSource, Inc. (NI: NYSE) with a dividend yield of 8.3%. With a forward price/earnings ratio of 9.0 times, NI also appears cheaper than AVA shares with a 12.8 time forward PE. NiSource was generating free cash flow until this year as cash flows from operations failed to cover the Company’s current capex program after working capital needs.

Nor is Avista the most efficient. Unitil Corp. (UTL: NYSE) has an inventory turnover of 45.5 times compared to the industry average of 12.8 and Avista’s average of 23.4 times. Unitil just completed the acquisition of a NiSource subsidiary valued at $200 million adding the complexity of deal financing to a decision on UTL shares.

Just like in buy a car (as if anyone is still doing that these days) it is a good idea to look under the hood to see what you are getting for your money. High yield and flashy “green” appearance may not be enough to justify the stake. Operating efficiency, cash generation and effective long-term growth strategies are vital.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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