Pinnacle West Capital is an Arizona/New Mexico utility company with a strong track record of dividend growth.
Recent headwinds have pushed the dividend yield to a multi-year high.
It’s expected to benefit from population and business growth and the stock appears to be trading in value territory.
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Justin Paget/DigitalVision via Getty Images Utility companies are often seen as income cousins to REITs, for the reliable income streams that they provide. For one reason or another, this sector has underperformed both the broader market and the Vanguard Real Estate ETF ( VNQ ) this year. As seen below, the Vanguard Utilities ETF ( VPU ) as returned just 2.8% this year, as opposed to the 29% and 33% returns of VNQ and the S&P 500 ( SPY ), respectively. (Source: Seeking Alpha)
As such, it appears that the utility sector may be ripe for value investors who seek higher yield. This brings me to Pinnacle West Capital ( PNW ), whose stock is trading well below its 52-week high, pushing its yield above 5%. I highlight what makes PNW a Buy at the current price, so let’s get started. PNW Is A Solid Income Play
Pinnacle West Capital is an energy holding company that has consolidated assets of $22 billion, with about 6,300 megawatts of generating capacity. It employs 6K employees in Arizona and New Mexico, and through its principal subsidiary, Arizona Public Service, it serves more than 1.3 million Arizona homes and businesses.
Notably, APS is the operator and co-owner of the largest nuclear plant and single-largest generator of carbon-free electricity in the U.S. APS has an aspirational goal of providing 100% clean and carbon-free electricity by the year 2050. In the trailing 12 months, PNW generated $3.75B in total revenue.
PNW has seen material share price weakness over the past twelve months, posting negative returns on both a YTD and 1-year basis. At the current price of $66, PNW is well below its 52-week high of $90 in the summer of this year. (Source: Seeking Alpha)
To be sure, PNW does have some recent headwinds that impacted its share price. This includes milder weather compared to last year, which resulted in less electricity generated for residential cooling during Arizona’s hot summer, and which contributed towards a 5.6% YoY decline in operating income, to $429M in the third quarter. Another factor that contributed to this decline was an active monsoon season that necessitated the replacement of 273 poles damaged by storms.
Last but not least, the Arizona Corporation Commission (Arizona’s public utility commissioner) provided an unfavorable decision to APS’s 2019 rate case. This includes a total bill decrease of $4.8M and a cut in the company’s return on equity from 10% to 8.7% – the lowest for any mid- to large-sized, investor-owned utility in the U.S.
Looking forward, I don’t see weather-related concerns as breaking the long-term investment thesis, considering its unpredictable nature. Plus, I’m encouraged to see that the Four Corners Power Plant (serving San Juan County in New Mexico) has made significant progress towards clean energy, with an estimated 20-25% carbon emissions reduction by 2023.
In addition, management appears prepared to put the rate case decision behind them and sees a favorable customer growth environment, as noted during the recent conference call : “Arizona remains among the fastest-growing states in the country, where other states are experiencing little or negative customer growth, we’re projecting 1.5% to 2.5% retail customer growth in 2021 and 3% to 4% weather normalized sales growth. We expect 43,000 housing permits this year in Maricopa County alone, levels that have not been reached since before the great recession. In particular, Phoenix is becoming a leader in attracting high-tech and data center customers. As you may remember, Taiwan Semiconductor broke ground on their $12 billion investment earlier this year, cementing Phoenix was one of the top semiconductor hubs in the country. More recently, Core Power announced their intention to build a 1 million square foot lithium-ion battery manufacturing facility. We’ll continue to focus our economic development approach on helping to attract and expand businesses and job creators.” – CEO of PNW Meanwhile, PNW maintains a strong BBB+ rated balance sheet, with a net debt to EBITDA ratio of 4.8x, which I find to be reasonable and under the 6.0x level I prefer for utilities. Management expressed confidence in the business outlook by raising the dividend by 2.4% this month, to […]