Valuation & Total Return
Here’s a look at how Vectren is thinking about its financial targets:
Source: Vectren, AGA Financial Forum, Slide 7
This is an interesting table in my view; with three distinct levers of control. The first lever is deciding how much cash to allocate toward dividends. We’ve seen that the payout ratios the company is targeting have more or less come in line recently. This is something the company has strong control over.
The next aspect is projected earnings growth; which is also in line with what analysts are anticipating. To be sure Vectren has a good amount of say here; however, not to the same degree as the payout ratio. Things can and do happen, leaving the growth rate a bit murkier.
Finally we can approach the top of the table – shareholder return. This is a nice anticipation, but in my view is somewhat out of the hands of the managers. Even if the firm grows exactly as it anticipates, there’s no mechanism that requires shares to move in lock step with this performance. Business results and shareholder returns are often two separate notions.
In the case of Vectren, the tendency for shareholders to underperform rather than outperform the business appears like a greater probability. Over the past decade shares of Vectren have traded hands at an average earnings multiple of about 16. In the past decade this multiple was still around 16, and only in the last five years or so has the average approached 17.
Based on a share price around $50 and anticipated earnings around $2.50, shares of Vectren are now trading at 20 times expected earnings – notably well above what has previously been normal. Naturally this could continue, but a prudent view might suspect that it could revert back as well.
Should both per share earnings and dividends growth by say 5% annually for Vectren, you might anticipate collecting ~$9 or so in cash dividends and see a future earnings-per-share number of about $3.20. With a future multiple of 16, this would equate to a share price of about $51 (basically where we sit today) and a total value of roughly $60. In turn, this would translate to an annualized compound gain of about 3.8% per annum.
Vectren may very well grow at 5% to 7% annually and pay out a near 4% dividend. Yet this does not automatically translate to investors receiving 9% to 11% gains. You also have to consider how the valuation might interact with the equation. In the case of Vectren, lagging rather than leading shareholder gains could very well be the case.
Final Thoughts
In short, Vectren has put together an enviable record of generating solid profits and paying out an increasing dividend. The consistency has been impressive – even for a utility. Moreover, the growth rate has actually been reasonably solid as well and this is expected to continue over the intermediate-term.
However, these items alone do not necessitate that it must be a solid investment. As a result of a much higher valuation (going from 15 times earnings in 2012 to 20 times today) a lot of the valuation proposition has faded away. Because of this, the company does not rank particularly well using The 8 Rules of Dividend Investing.
Note: This article was written by Eli Inkrot and was originally published on Sure Dividend.
