We Just Bought Avista (AVA) for DTA’s Income Builder Portfolio

Smokes, booze and weed: Philip Morris (PM), Altria (MO), Constellation Brands (STZ) …  Junk food, sugary drinks and salty snacks: McDonald’s (MCD), Pepsi (PEP).

Big Oil: Chevron (CVX)Coal-burners: NextEra Energy (NEE), Dominion Energy (D), American Electric Power (AEP).

Overpriced drugs: Johnson & Johnson (JNJ), Amgen (AMGN), AbbVie (ABBV)Weapons of mass destruction: Lockheed Martin (LMT), General Dynamics (GD).

Obviously, when putting together DTA’s Income Builder Portfolio, I haven’t exactly been politically correct, health-minded or socially conscious.

I am neither ashamed of that fact nor proud of it.

If I avoided every company that makes a product somebody might find objectionable, the only thing left to invest in would be Rainbows & Unicorns R Us.

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As an investor, I want to own high-quality companies with proven business models that will create wealth, grow dividends and pave the way for financial independence.

So I certainly didn’t select the IBP’s latest addition — Pacific Northwest utility Avista (AVA) — just because it focuses on “green” energy.

On Tuesday, June 9, I executed a purchase order on Daily Trade Alert’s behalf for 26 shares of AVA at $38.75 apiece.

(As can happen with limit orders, the buy executed via two transactions a split-second apart.)

Simply stated, I chose AVA because I thought it could help the IBP reach the income-growing and total-return goals laid out in our Business Plan.

Nevertheless, Avista’s commitment to renewable power did factor into my decision.

Why? Because I think it’s good business.

Increasingly, it’s what customers — and the government bodies that regulate utilities — want and expect from the companies that provide electricity.

Here is what Avista CEO Dennis Vermillion said in his letter to shareholders at the beginning of the 2019 annual report:

We boldly established Avista’s Clean Energy Goals to serve our customers with carbon-free electricity by 2045 and carbon-neutral electricity by the end of 2027. People expect energy to be clean, reliable and affordable. Achieving this balance is one of the biggest challenges facing the energy industry. Our generation portfolio is already more than half renewables, so we’re starting from a solid position.

The first three utilities we bought for the IBP also are quite green, especially NextEra Energy, which has the largest market share of North American wind capacity.

What makes Avista unique is that about 50% of the energy it produces comes from hydropower, taking advantage of the plentiful water supplies in Idaho, Oregon, Washington and Alaska.

It’s both good for the environment and smart business stragegy, truly a win-win scenario.

Income Aplenty

Most Dividend Growth Investing practitioners appreciate the reliable, increasing income production that good utilities tend to provide.

As I pointed out in my previous article, Avista scores nicely in that department, having steadily raised its annual dividend for 18 consecutive years.

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At AVA’s quarterly payout of .405 per share, our position will generate $10.53 in income in September. Immediately and automatically, that will be reinvested right back into Avista stock, buying about .26 of a share more.

Then, three months later, the slightly larger position will result in a $10.64 dividend, which will buy yet another fraction of a share.

That same procedure takes place over and over again for all 32 IBP components, which is how our project got its name.

Valuation Station

With a market cap of about $2.7 billion, Avista is dwarfed by the three other utilities in the IBP, NextEra, Dominion and American Electric.

And because AVA is a mid-cap company (and almost a small-cap), few analysts follow it.

Two of the main sources I use to figure valuations of companies, Morningstar and CFRA, do not track Avista, so we’ll have to turn elsewhere.

Simply Safe Dividends says AVA’s current 4.1% dividend yield is 23% higher than its 5-year average (3.35%). In addition, Avista’s 18.7 forward P/E ratio is lower than its 5-year average (21.7). Data points like those signal a stock might be undervalued.

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Value Line includes Avista in its 1,700-stock universe, and the following graphic supplies some interesting information.

Relative P/E (red-circled area) compares the price/earnings ratio of one stock with the median of estimated P/E ratios of all stocks under Value Line review. Avista’s sub-1 ratio indicates possible undervaluation.

VL believes Avista could experience 15% to 54% price appreciation over the next 3-5 years (purple) and an even wider range over the next 18 months (green).

Ford Equity Research says Avista will outperform the market in the coming year, but Schwab is not as optimistic.

Looking at FAST Graphs, one can see how the economic situation brought about by the COVID-19 pandemic complicates things.

It appears that AVA is a little undervalued because its “Blended P/E ratio” of 15.77 is lower than its post-Great Recession norm of 17.08.

However, an expected 36% reduction in earnings per share in 2020 (red-circled area) messes with the figures. (This situation is not unique to AVA or utilities; thousands of companies are facing something similar.)

The good news is that earnings are forecast to pick back up after that (yellow highlight). The 10% projected EPS growth for 2021 is quite strong for a utility.

Wrapping Things Up

My grand-twins Logan and Jack turned 10 months old this week.

We share more than the same barber; we also share a desire to breathe clean air, drink clean water, play in green parks and climb tall trees. (They don’t know it yet, but it’s true!)

So sure, I want all utilities to parrot Avista by moving away from coal and embracing renewable energy production.

But again, that’s not why I picked AVA for the IBP.

I just happen to think it’s a well-run utility that will enhance the overall performance of the portfolio.

— Mike Nadel

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Source: Dividends and Income