TECO Energy, Inc. (NYSE:TE) is buying New Mexico Gas to grow its bottom line, move into a new market, and diversify into natural gas. TECO Energy, Inc. (NYSE:TE) has purchased other gas companies like West Florida Gas and thinks it can repeat the same success with New Mexico Gas. TECO is trading at a premium on a book valuation to NV Energy with a price to book of 1.67 compared to 1.56 for NV Energy (which is after the 23% premium).
Every industry goes through a period of consolidation at some time or another, and valuations of some of the smaller players increases. Consolidation can lead to premiums in the smaller players as speculation drives up the value of the stock.
Black Hills Corp (NYSE:BKH) is another company that is small enough to be purchased by a bigger player. Black Hills Corp (NYSE:BKH) is a utility company that offers both electricity and natural gas to its customers in Colorado, Montana, South Dakota, and Wyoming. With a book value of $2.1 billion (and debt of $1.27 billion) with a book ratio of 1.7, it is trading in line with industry valuations.
Utilities aren’t able to grow much unless they buy up other players and become bigger entities. Black Hills Corp (NYSE:BKH) offers 6% long term growth and an area of operation undergoing an economic boom right now. In the area where Black Hills Corp (NYSE:BKH) operates there is a lot of potential for growth, because parts of Montana and South Dakota will start seeing more oil activity as land in the Bakken (primarily North Dakota) gets more and more expensive, pushing the smaller players to seek cheaper land elsewhere.
TECO and Black Hills
TECO and Black Hills Corp (NYSE:BKH) are both interesting investments for long term dividend investors. TECO pays out a whopping 5% yield, which would provide you a decent return even if the stock didn’t move very much. TECO is projected to grow its EPS by 3% in the long term, but with the recent acquisition, 4-5% growth is foreseeable in the near future. With a PE of 15.9 this stock is fairly valued, but the dividend yield is very attractive for a conservative portfolio.
Black Hills Corp (NYSE:BKH) pays out a 3.2% dividend yield and is projected to grow EPS by 6% over the next several years. Black Hills has a high PE ratio of 21.65 for a company growing at a mid single-digit rate, so I wouldn’t be a buyer at this level. If Black Hills falls enough so the PE ratio is in the 16-18 range then this stock would be a nice addition to a conservative dividend portfolio, and the possibility to be bought out adds upside.
Final thoughts
I think that the utility market will continue to consolidate as the smaller companies merge into the bigger ones to decrease fix costs and offer growth potential to the large firms, which is why utilities have high payout ratios. So to grow, utilities purchase up other firms that are trading at a discount and will offer steady growth with a good macro picture behind it, like NV Energy.
Financing for these big deals is dirt cheap right now, and if QE is going to be tapered, they might as well buy now while financing is still cheap. These buyouts will push up valuations, and Black Hills and TECO are both small enough and trading near industry valuations; they could possibly be purchased. They also pay out big dividends and offer low risk growth tried to bullish macro trends.
The article Rising Valuations in Utilities originally appeared on Fool.com.
Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Callum is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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