Stocks’ Details

Improved Business Outlook Driven by Industry Transition:  Emera Incorporated (TSX: EMA) owns and provides cost-of-service rate-regulated electric and gas utility services across the regions like Canada, the United States and the Caribbean. The business operates across five segments which are namely Florida Electric Utility, Canadian Electric Utilities, Other Electric Utilities, Gas Utilities and Infrastructure and Other. The company intends to deliver safer, cleaner, affordable and reliable energy to the end-users.

Business Model: The key drivers for the utility business is the rate of return on equity or rate base and a capital structure approved by the regulator, prudent cost management, energy volume, and the timing of the CAPEX. Electric and gas sales volumes are correlated with general economic conditions, population and weather. The business derives its revenue from both commercial and residential customers.

Investment Rationale:

• Capital Investment to Drive Business Growth: The group is planning to invest ~CAD 6.9 billion over next three years and will be looking for opportunities and intends to invest additional CAD 500 million to CAD 1 billion in the near to medium term. The group will be making the rate-based investment in renewable and cleaner energy. The scope of investment will also include the modernization of infrastructure and technology development. These investments would enable the group to achieve a rate base growth of ~7% per annum till FY22.

• Dividend Play: The stock is offering a dividend yield of more than 5%. Since 2000, the dividend increased at a CAGR of ~6% and the management is planning to hike its dividend by ~4% to 5% over the next few years. The group is targeting a long-term payout ratio in the range of ~70% to 75%. 

• Funding requirements to be met by cash flow from operations: The group has a decent cash flow generation and planning to meet ~50% -55% of its near-term funding requirement from internal cash flow generation and ~25% to 30% via various equity instruments. 

• Opportunities Across Aging Energy Infrastructure Segment: Energy markets worldwide are facing considerable change, and the company is well-positioned to meet the shift in customer demands, complex regulatory environments and the trend towards decarbonization. The group is also looking for the opportunities in the field of renewable generation, battery storage industries and aging infrastructure segment.

• Investments in Renewable Energy to Boost Long-term Growth: The business intends to follow the industry trend, where players are concentrating on carbon reduction model and the business is aiming to invest in the renewable and cleaner generation to reduce the carbon intensity of the operations. The company is planning to invest US$ 800 million to install 600 MW new utility-scale solar photovoltaic projects by FY21. The company is also investing US$ 850 million to repower Unit 1 with natural gas combined cycle technology, which is expected to complete in FY23.

• Focus on Balance Sheet Strengthening: The group is continuously focusing on strengthening its capital structure. The company is targeting to reduce the debt contribution to 55% from 65% reported in 2016.

FY19 Operational Highlights for the Period Ended 31^st December 2019: EMA came up with its full-year results, wherein the company posted operating revenues of CAD 6,111 million, as compared to CAD 6,524 million in FY18. The decline was primarily triggered by lower income from other segment due to the sale of NEGG and Bayside along with decrease at Florida Electric Utility on account of lower base rates as a result of US tax reform. Operating expense decreased by CAD358 million and stood at CAD 4,768 million. The decline in operating expense was driven by lower expenses reported from other segment on account of sale of NEGG and Bayside coupled with tax reform benefits and lower fuel cost in Florida electric utility segment, while higher costs in Canadian Electric Utilities remained a drag. Adjusted EBITDA came in at CAD 2,339 million, as compared to CAD2,387 million in FY18. Net income came in lower at CAD710 million, from CAD 747 million reported in the previous financial year.

Key FY19 Financial Highlights (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 16.21% of the total shareholding. The Vanguard Group, Inc. and TD Asset Management Inc. hold the maximum interests in the company at 3.03% and 3.02%, respectively.

Top 10 Shareholders (Source: Thomson Reuters)

Key Risks: The business has a major portion of its debt in US-denominated currency. In the recent past, the US currency has become stronger, as compared to the other major currencies across the globe. Thus, a stronger US currency and weaker CAD is likely to drive its interest component higher. The group faces a weather risk as well. Seasonal patterns and other weather events affects demand and operating costs related to the business.

Key Metrics: The Company reported decent numbers in FY19, wherein EMA posted EBITDA margin at 37.4%, higher than FY18 of 36.7%. Debt to capital improved to 2.08 from 2.27 and 2.36 reported in 2018 and 2017, respectively. The business successfully reduced its debt component, which suggests improved Balance Sheet. Operating margin also improved from 21.4% in FY18 to 22% in FY19. The group reported marginal improvement in its net margin at 11.6% from 11.5% in the previous financial year.

Key Valuation Metrics (Source: Thomson Reuters)

Outlook: Within the Florida segment, the group is planning to invest ~ US$ 1billion out of which US$ 850 million is expected to spend to upgrade Tampa Electric’s Big Bend Power Station. Within the Canadian Utility segment, NSPI is planning to invest ~CAD 375 million to support system reliability and infrastructure renewals. Within the Peoples Gas System (PGS), the group expects customer growth rates to remain at par with FY19, reflecting economic growth in Florida and the optimization of existing opportunities.

For the next two years, the group is expected to invest majorly (~99%) in the regulated utilities. The primary focus on electric utility which is going to account for ~74% of total investments while remaining would be going to Gas utilities. In terms of locations, the group is investing ~70% of its total planned investment in Florida while ~20% in Atlantic Canada.

Valuation Methodology: EV/ EBITDA Based Relative Valuation

EV/EBITDA Based Valuation (Source: Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: Typically, utility companies are known for respective defensive stocks because of their bare essential characteristics; people need them during all phases of the economic cycle. Also, these companies tend to be benefited amid economic downtrend as because of lower interest expenses and their competition to borrow is much less as well. Shares of EMA have declined about 7% in the past five trading sessions and 14% on a YTD basis, however, outperformed the benchmark index by 8% and 26% in the same period, which exhibits a defensive business model of the group. Further, its shares are offering a lucrative dividend yield of 5.09% amid a time when yields on fixed-income securities are falling substantially; this is one crucial measure from an income investors point of view. The stock made a 52-week low and high of CAD 44.98 and CAD 60.94 and is currently trading close to the lower band of its 52-week’s trading range. The stock has corrected by ~19.87% and ~16.63% in the last one month and six months, respectively. The stock reported consistent performance in the recent past and outperformed both the TSX Composite Index and the TSX Capped Utilities Index. The company earns ~95% of earnings derived from regulated investments, of which 55% is in Florida. The company has a visible growth plan of more than CAD7.5 billion consisting of capital investment plan to drive rate base growth through FY22. We have valued the stock using EV/EBITDA based relative valuation method. For this, we have considered peers like Fortis Inc (TSX: FTS), Hydro One Limited (TSX: H), and Algonquin Power & Utilities Corp (TSX: AQN), etc., and arrived at a target price which is offering a lower double-digit upside (in % terms).  Hence, we give a ‘Buy’ recommendation on the stock at the closing price of CAD 48.10, down 2.82% as on 20^th March 2020. 

EMA Daily Technical Chart (Source: Thomson Reuters)

Disclaimer

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