CenterPoint Energy: Buy This High-Growth Utility On Dips (NYSE:CNP)

CenterPoint Energy, Inc. (NYSE:CNP) is a regulated electric and natural gas utility that serves customers throughout various states in the central part of the country. The utility sector has long been a favorite among conservative investors, such as retirees, due to its general stability and high dividend yields. CenterPoint Energy is no exception to this, as its 2.45% yield is higher than the average company in the S&P 500 Index (SP500), but it is unfortunately not especially high for the utility sector. The company does make up for this with its strong growth prospects that greatly exceed those of just about any other utility that I have covered in this column over the past several months.

Unfortunately, an investor does have to pay through the nose for these good things, as CenterPoint Energy looks incredibly expensive relative to its peers. This is something that has been the case for quite a while, as I discussed in my last article on the company. The valuation might be enough to discourage some investors from it, but let us investigate further and see if the company offers enough good things to justify the high price.

About CenterPoint Energy

As stated in the introduction, CenterPoint Energy, Inc. is a regulated electric and natural gas utility that serves customers throughout various states in the central part of the country. These states include Indiana, Louisiana, Minnesota, Mississippi, Ohio, and Texas. This is admittedly something of a strange service territory as not all of these states are contiguous. As might be expected, the company came about through a series of mergers, acquisitions, and corporate separations that occurred once Texas and a few other states began to deregulate their utilities.

As stated in the introduction, one of the biggest reasons why conservative investors like utilities is because of their stable cash flow. This makes a great deal of sense since most people consider the provision of electricity and natural gas in their homes to be a necessity for life today. Indeed, various laws and government programs consider these services to be essential. This is particularly evident in the winter months as many states have laws forbidding utilities from disconnecting services to low-income homes if they cannot afford to pay their bills. As a result of this, we can assume that most people will prioritize paying their utility bills over discretionary expenses during times when money gets tight.

The effects of this characteristic can be seen quite clearly by looking at CenterPoint Energy’s operating cash flows. Here they are over the past eleven quarters:

As we can clearly see, there is not really a great deal of variation from one quarter to the next. With that said, we can see that the third quarter is consistently the weakest. This is not unexpected, as it is caused by the fact that CenterPoint Energy is primarily a natural gas utility. The company has 4.2 million natural gas customers within its service territory, but only 2.8 million electric customers:

This is important for the company’s cash flows because the primary use of natural gas is for the space heating of homes and businesses. This results in much higher consumption during the fourth and especially the first quarters of the year relative to the second and third. This obviously causes CenterPoint Energy to see its greatest cash flows during those quarters in which the consumption of natural gas is higher. It, therefore, would make sense to look at the company’s cash flows over a twelve-month period in order to balance out the effects of this seasonality and better show its stability. Here are CenterPoint Energy’s trailing twelve-month operating cash flows for each of the past eleven quarters:

We certainly see that there is not a great deal of variation here, with the exception of 2021. The reason for the weakness in the 2021 numbers was the Texas deep freeze that occurred in February of 2021. This caused natural gas prices in the state to temporarily spike to incredibly high levels, which cost utilities a lot of money.

We can see the same kind of disruption in the cash flows of every other utility that operates in Texas, such as Entergy (ETR). This storm was a once-in-a-century event, and it is unlikely that something like that will occur again during any of our lifetimes. Thus, we can see that CenterPoint Energy should remain very stable going forward, since the operating cash flows for any given twelve-month period that does not include February 2021 are generally around the same level. This is something that we can very much appreciate today given the fact that nearly every analyst is expecting a recession to occur sometime over the next twelve months, which means that it can be a smart move to be holding assets that will not be affected very much by such an event.

Naturally, as investors, we are not satisfied with mere stability, as we desire growth from a company that we are invested in. Fortunately, CenterPoint Energy is well-positioned to deliver such growth. The primary way through which the company will accomplish this is by growing its rate base. The rate base is the value of the company’s assets upon which regulators allow it to earn a specified rate of return. As this rate of return is a percentage, any increase to the rate base allows the company to increase the price that it charges its customers in order to earn that specified rate of return. The usual way by which a company will increase its rate base is by investing money into upgrading, modernizing, or even expanding its utility infrastructure. CenterPoint Energy is in the process of doing exactly this as the company has unveiled a plan to spend $43 billion over the 2021 to 2030 period on improving its infrastructure:

This is a far lengthier plan than what has been provided by most other utilities and as investors, we can appreciate this. Although we are now in the third year of this plan, we still have visibility into the company’s growth plans for the next seven years. The majority of CenterPoint Energy’s peers have provided us with an outlook only to 2026 or 2027. Although there may not be a huge impact on our investment thesis from this longer-term outlook, it still shows that CenterPoint Energy is aiming to be shareholder-friendly and addresses one of the complaints that I had about FirstEnergy (FE) in a recent article.

One of the characteristics of CenterPoint Energy, Inc.’s plan is that it is rather front-loaded, with more growth occurring in the early years than in later ones. We can see this in the impact that the program will have on CenterPoint Energy’s rate base. The company’s rate base should grow from $17.6 billion in 2021 to $27.8 billion by the end of 2025. That is an 11% compound annual growth rate:

However, the growth declines somewhat over the 2026 to 2030 period. As a result, the plan will only grow the company’s rate base at a 9.5% compound annual growth rate over the entire ten-year period. Thus, the period out until the end of 2025 will have somewhat greater growth than the period encompassing 2026 to 2030. This will likely result in CenterPoint Energy having somewhat greater earnings growth during the first half of this ten-year period.

Indeed, CenterPoint Energy has stated that it should be able to grow its earnings per share at an 8% annual rate until the end of 2024, which drops to 6% to 8% thereafter until 2030. When we combine this with the company’s current dividend yield, CenterPoint Energy should be able to provide investors with a total average annual return of 10% to 11% in 2023 and 2024 and then 8% to 11% going forward. This is a reasonable total return for a utility, although the low end of the range is below what most of CenterPoint Energy’s peers are positioned to deliver.

Financial Considerations

It is always important that we investigate the way that a company finances its operations before we make an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. This is usually accomplished by issuing new debt to repay the existing debt, which can cause a company’s interest expenses to increase following the rollover depending on the conditions in the market. In addition to this, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes a company’s cash flows to decline can push it into distress if it has too much debt. Although utilities such as CenterPoint Energy tend to have remarkably stable cash flows, we have seen bankruptcies occur in the sector so this is still a risk that we should not ignore.

One metric that we can use to evaluate a company’s financial structure is the net debt-to-equity ratio. This ratio tells us the degree to which a company is financing its operations with debt as opposed to wholly-owned funds. The ratio also tells us the degree to which the company’s equity can cover its debt obligations in the event of a bankruptcy or liquidation event, which is arguably more important.

As of September 30, 2022, CenterPoint Energy had a net debt of $15.005 billion compared to $9.989 billion of shareholders’ equity. This gives the company a net debt-to-equity ratio of 1.50 today. Here is how that compares to some of the company’s peers:

Company	Net Debt-to-Equity Ratio
CenterPoint Energy	1.50
CMS Energy (CMS)	1.81
Entergy Corporation (ETR)	2.14
The AES Corporation (AES)	3.66
Ameren Corporation (AEE)	1.45

Click to enlarge

As we can see here, CenterPoint Energy appears to be quite reasonably financed relative to its peers. Although it is not the least levered company in the industry, it is certainly not bad at all compared to many of its peers. This is a good sign because it indicates that the company is not employing too much debt in its financial structure. As a result, CenterPoint Energy’s debt is not likely to pose a particularly outsized risk to us as investors.

Dividend Analysis

As stated in the introduction, one of the biggest reasons why many investors purchase shares of utility companies are because of the relatively high yields that they tend to possess. This is due to the relatively low-growth nature of these companies. A utility like CenterPoint Energy will not experience growth that is even comparable to a young technology company or similar entity. Thus, a utility is unlikely to deliver outsized returns in the form of capital gains so they aim to simply pay out a significant proportion of their profits to the shareholders in order to provide a return.

In addition, the low growth causes these stocks to have relatively low valuations, which results in the dividend being fairly high relative to the stock price. CenterPoint Energy is no exception to this, as the stock yields 2.45% at the current price. This is relatively in line with the 2.37% of the U.S. Utilities Index (IDU), but it is substantially higher than the 1.59% of the S&P 500 Index (SPY). Unfortunately, CenterPoint Energy does not have nearly as strong of a dividend history as some of its peers:

The big thing that we note here is that CenterPoint Energy was one of the only utility companies that cut its dividend back in 2020. The company claimed at the time that this action was intended to improve its liquidity and financial strength, although it is curious that the firm’s peers never saw a reason to cut. Fortunately, CenterPoint Energy’s history since that time is commendable, with the company boosting the dividend every few quarters. The fact that it is increasing its dividend is nice to see during inflationary times like we are experiencing today because inflation is constantly reducing the number of goods and services that we can purchase with the dividend that the company pays out. This can make it seem as if we are getting poorer and poorer with the passage of time. The fact that CenterPoint Energy keeps increasing the amount that it pays out helps to offset this effect and maintains the purchasing power of the dividend.

Although the company’s past is not particularly encouraging, anyone buying today will receive the current dividend at the current yield. As such, the most important thing for our purposes is whether or not the company can actually afford the dividend that it pays out. After all, we do not want to be the victims of another cut that reduces our income and almost certainly causes the stock price to decline.

The usual way that we analyze a company’s ability to maintain the dividend is by looking at its free cash flow. The free cash flow is the money that was generated by a company’s ordinary operations and is left over after it pays all of its bills and makes all necessary capital expenditures. This is money that can be used for such purposes as reducing debt, buying back stock, or paying a dividend. During the twelve-month period ending September 30, 2022, CenterPoint Energy reported a negative levered free cash flow of $284.8 million. This is obviously not enough to pay any dividend yet CenterPoint Energy actually paid out $484.0 million during that period. At first glance, this could be concerning as the company is not generating enough cash to cover its dividend.

However, it is not uncommon for utilities to finance their capital expenditures through the issuance of equity and especially debt. These companies then cover their dividends out of operating cash flow. This is due to the high costs involved in constructing and maintaining utility-grade infrastructure over a wide geographic area. If utilities did not use this method of financing, it would be impossible for them to actually provide the services that people demand from them. During the twelve-month period ending on September 30, 2022, CenterPoint Energy reported an operating cash flow of $1.864 billion. This was more than sufficient to cover the $484.0 million that the company paid out in dividends with an enormous amount of money left over that can be used for other purposes. In fact, the company could probably afford to double its dividend and still be fine financially. Thus, it does appear that it should have no real trouble maintaining the dividend at the current level.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a regulated utility like CenterPoint Energy, Inc., one metric that we can use to value it is the price-to-earnings growth ratio. This is a modified version of the familiar price-to-earnings ratio that takes a company’s earnings per share growth into account. A price-to-earnings growth ratio of less than 1.0 is a sign that the stock may be undervalued relative to its forward earnings per share growth and vice versa. However, there are very few stocks in today’s hot market that have a ratio that is such a low number. That is particularly true in the slow-growing utility sector. Thus, the best way to use this ratio is to compare CenterPoint Energy’s valuation against its peers in order to determine which company is the most attractive buy today.

According to Zacks Investment Research, CenterPoint Energy will grow its earnings per share at a 3.53% rate over the next three to five years. That seems very low since the company’s rate base growth alone should result in it having a 6% to 8% earnings per share growth rate over the projection period. The Zacks estimate gives CenterPoint Energy a price-to-earnings growth ratio of 5.92, which is incredibly expensive compared to its peer group:

Company	PEG Ratio
CenterPoint Energy	5.92
CMS Energy	2.49
Entergy Corporation	2.64
The AES Corporation	1.85
Ameren Corporation	2.99

Click to enlarge

As we can see, CenterPoint Energy appears to be incredibly expensive relative to its peers. However, as just mentioned, the earnings per share growth that we used to calculate CenterPoint Energy’s valuation seems to be too low given the company’s rate base expansion. If we use a more reasonable earnings per share growth rate then the stock begins to look much more comparable to its peers. For example, a 6% growth rate gives a ratio of 3.48 while an 8% growth rate gives a ratio of 2.61.

Admittedly, the company still looks a bit expensive relative to its peers even given these higher growth rates but it is not ludicrously out of line with its peer group, especially with the 8% growth rate figure. I would still recommend waiting a bit to see if the price comes down somewhat though since an 8% long-term growth rate is rather unlikely.

Conclusion

In conclusion, CenterPoint Energy, Inc. is an interesting regulated electric and natural gas utility that is positioned to deliver very strong growth over the coming few years. The company is very recession-resistant, which is something that should be appealing today as the economy is likely to enter a recession sometime this year.

Unfortunately, CenterPoint Energy, Inc.’s valuation appears a bit stretched, but its strong balance sheet and dividend coverage help to offset this. Overall, CenterPoint Energy, Inc. might be worth buying whenever the stock price dips.