Black Hills: This 3.4%-Yielding Stock Is Undervalued

Investment Thesis

Black Hills (NYSE:BKH) saw its EPS decline in Q1 2020 primarily due to unfavorable weather conditions. The company has $2.7 billion of capital projects to help grow its EPS in the next five years. It has recently lowered its 2020 guidance slightly due to the negative impact of COVID-19, but believes that the impact will gradually recede in the second half of 2020. Black Hills currently pays a 3.4%-yielding dividend and is trading at a discount to its peers. Therefore, this is a stock worth considering for investors seeking both dividend growth and some capital appreciation.

Data by YCharts

Recent Developments: Q1 2020 Highlights

Black Hills had a challenging Q1 2020 as the company saw its earnings per share decline to $1.51 per share from $1.73 per share in Q1 2019. The impact was primarily due to adverse weather conditions in its service territories. Management estimated that the impact was about $0.19 per share.

Source: Q1 2020 Investor Presentation

Earnings and Growth Analysis

$2.7 billion of capital investments between 2020 and 2024

Black Hills plans to spend about $2.7 billion in capital expenditures between 2020 and 2024. As can be seen from the table below, the company expects to invest about $669 million and $555 million in 2020 and 2021 respectively, and about $4.7-$4.8 million annually between 2022 and 2024. As can be seen from the chart below, majority of its investments will be in its electric and gas utilities (about 94% of its investments are in its utilities). These investments will help grow its rate base and EPS in the next five years. Although management has not provided its rate base and EPS growth guidance for the next five years, we know from past data that its rate base has nearly doubled since 2014 and its EPS has increased by about 3.5% annually in the past five years.

Source: June 2020 Investor Meeting

Guidance revised slightly lower due to COVID-19

Although not material, management estimated that the outbreak of COVID-19 will likely still impact Black Hills’ 2020 EPS by about $0.05-$0.10 per share. Therefore, Black Hills has lowered its 2020 guidance by about $0.10 per share to the range of $3.45-$3.65. While Q2 electricity and natural gas usage has been down primarily due to lower commercial and industrial usages, management expects demand to improve gradually in the second half of 2020. We think management will be able to achieve its target given that the U.S. Midwest (the region where it operates its businesses) has done a much better job containing the virus than other regions of the U.S.

Source: June 2020 Investor Meetings

A solid balance sheet to support its capital projects

Black Hills has an investment-grade balance sheet with credit ratings of Baa2 (Moody’s) and BBB+ (S&P and Fitch). The company has a healthy funds from operations to debt ratio of about 14%. It has a manageable debt maturities profile with no large maturities before 2023. Black Hills also has ample access to liquidity with $750 million of revolving credit facility in place through 2023. Management plans to fund its capital expenditures in 2020 through funds generated from operations, debt financing, and some equity issuance. In fact, the company has issued a $100 million of equity back in February and plans to keep its net debt to capitalization ratio in the mid-50% over the long term.

Source: June 2020 Investor Meetings

Valuation Analysis

Black Hills currently trades at a forward P/E ratio of 16.98x. This is below its five-year average of 18.20x. Its valuation is also below its peers – Avista’s (NYSE:AVA) 18.53x and American Electric Power’s (NYSE:AEP) 20.01x. Therefore, we think Black Hills is currently undervalued.

Data by YCharts

A growing 3.4%-yielding dividend

Black Hills has increased its dividend for 50 consecutive years. The company currently pays a quarterly dividend of $0.535 per share. This dividend is equivalent to a dividend yield of about 3.4%. Black Hills’ dividend is sustainable as management has typically kept its payout ratio around 50-60% of its annual EPS target.

Data by YCharts

Risks and Challenges

Regulatory risks

Black Hills may face regulatory and legislative risks that might result in lower allowed returns in the future.

Weather and natural disasters

Unfavorable weather conditions and natural disasters can impact Black Hills’ revenues and earnings negatively in the future.

Multiple waves of pandemic

Multiple waves of pandemic may cause significant decline in economic activities. In such a scenario, Black Hills may need to revise its 2020 EPS guidance.

Investor Takeaway

Black Hills should continue to grow its EPS and dividend annually thanks to its $2.7 billion capital projects that it plans to invest through 2024. The company also pays a growing 3.4%-yielding dividend and its shares appear to be undervalued. Therefore, we think this is a stock to consider for investors seeking both capital appreciation and dividend growth.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.