As much as I have enjoyed the process of putting together DTA’s Income Builder Portfolio, sometimes it presents a real challenge.
This is one of those times.
Most high-quality companies either are very overvalued, or they already are represented in the IBP with sizable positions (or both).
Courageous hero that I am, however, I will keep building.
Yeah … I know … America salutes me!
This conundrum — I want to choose quality companies, but their stock prices have skyrocketed despite the economy being roiled by the COVID-19 pandemic — has me looking far and wide for investing ideas.
My latest search has led me to the U.S. Northwest for a relatively unknown utility that has been raising dividends for years, has decent growth prospects, is committed to renewable energy … and is at least kinda, sorta reasonably valued.
After the market opens today (Tuesday, June 9), I plan to execute a purchase order for about $1,000 worth of stock in Avista (AVA).
Avista will become the IBP’s 32nd component and 4th utility.
Each of the first three — NextEra Energy (NEE), Dominion Energy (D) and American Electric Power (AEP) — has done very well for the portfolio, both in income production and total return.
Over the last couple of years, utilities have outperformed the overall market by a wide market.
That excellent showing has occurred even though the sector is considered “defensive” in nature.
I obviously appreciate the role utes can have in a Dividend Growth Investing portfolio, but the sector makes up only 13% of the IBP, as we’ve been on a bit of a tech-stock binge lately.
While all of the above might explain why I wanted the IBP to have more exposure to utilities, it doesn’t explain why I have selected the smallest one by market cap ($2.67 billion) on my entire watch list.
For one thing, I want diversification in a portfolio, and that includes variety within sectors.
NextEra and Dominion are two large utilities based in the Southeast, so I didn’t want to choose similar companies such as Duke (DUK) or Southern (SO).
AEP is predominantly a Midwest operation; although I would have considered others from that region, top choices such as WEC Energy (WEC) and Xcel Energy (XEL) are very expensive now.
I like the geographic diversification that Avista brings, as shown in the following two slides from the company’s presentation at the 2019 AGA Financial Forum:
And come April 2022, Avista will enter the Western Energy Imbalance Market, a voluntary bulk power-trading market that currently has 14 utilities encompassing 70% of the load in that part of the country.
As AVA describes it:
The EIM’s advanced market systems automatically calculates the lowest-cost energy profile and sends dispatch signals every 5 minutes to serve real-time customer demand across a wide geographic area. Participating utilities maintain control over their generation assets, and remain responsible for balancing generation and load requirements, while sharing market benefits.
According to Avista, the cost will be minimal and the financial benefit will be significant.
Avista is coming off a solid quarter in which it easily beat earnings estimates. However, due largely to the effect of the global pandemic, it did lower full-year guidance slightly.
Earlier in this article, I included a graphic showing how well the IBP’s utility positions (and the sector overall) have performed relative to the market.
Avista actually has been a loser as a stock, as the following image shows, but there is a reasonable explanation.
In July 2017 (red X), the announcement that Avista would be acquired by Canadian utility Hydro One sent the stock price soaring. (Disclosure: I owned AVA in my personal portfolio back then but sold it shortly after this big price run-up.)
AVA remained around $50/share until January 2019 (purple X), when the deal fell apart and the price plummeted.
The price climbed slowly over the next year, as the overall market surged, but it collapsed this past winter (green X) along with the rest of the market. It closed Monday at $39.56.
Trading at about 20 times expected 2020 earnings, AVA is not a bargain, but it is much less expensive than the likes of NEE, WEC and XEL. (I will delve deeper into valuation in my post-buy article, which will be published Wednesday, June 10.)
I think Avista is very “investable,” but I am not trying to pass it off as a blue-chip company. With its BBB credit rating, and its less “growthy” history, it is no NextEra.
Nevertheless, finviz.com says AVA is expected to grow annual earnings at about a 6% rate over the next 5 years — better than several larger, better-known utilities such as Duke, Southern and Commonwealth Edison (ED).
Avista also is located in a part of the country that is seeing significant population growth, which is almost always good for a utility’s bottom line.
Jefferson Research’s “Financial Sonar” indicates that AVA has a solid balance sheet.
In addition, Value Line gives Avista its second-highest score for “Safety” (2) and third-highest for Financial Strength (A).
Avista has been paying dividends without interruptions or reductions since the turn of the century, and it has grown its annual payout to shareholders for 18 consecutive years.
At 4.1%, AVA’s yield will rank in the top 10 of Income Builder Portfolio holdings.
Somewhat concerned about Avista’s approximately 80% payout ratio and 50% debt/capital ratio, Simply Safe Dividends gives the company a score of 65 — the low end of SSD’s “Safe” range (60-79).
Comparing that to other utilities in the portfolio, NEE is at 99, AEP at 81 and D at 75.
Wrapping Things Up
As a new grandfather of twin boys, I want Jack and Logan’s generation to be able to live in a clean world … so I like that being green matters to Avista.
That wasn’t my main motivation for selecting AVA for the IBP, but it is part of what I consider an attractive overall package.
With the market running ever higher despite the economic headwinds brought about by COVID-19, finding solid, dividend-growing companies at decent price points is a challenge.
Indeed, I had to go a little “off the beaten path” to find Avista.
AVA isn’t perfect — no stock is — but it checks a lot of boxes, and I expect it to be a productive component of the Income Builder Portfolio for years to come.
As always, this is not a recommendation to buy any stock, and investors are urged to conduct their own thorough due diligence before making any purchase.
— Mike Nadel
The goal? To build a reliable, growing income stream by making regular investments in high-quality dividend-paying companies. Click here to access our Income Builder Portfolio and see what we’re buying this month.
Source: Dividends and Income