Emera: Florida Rate Base Assets Should Generate Interest

Emera Incorporated (OTCPK:EMRAF) (EMA.TO) (TSX:EMA:CA) is a Canadian-based electric utility often overlooked and misunderstood by utility sector investors. I have been a shareholder for almost 10 years and have followed the company since it started playing equity banker for sister Canadian utility Algonquin Power (AQN) in 2010. I am looking to add to my position with further stock weakness based on Emera’s attractive yield, market valuation, and most importantly, its regulatory environment.

Emera is a holding company for 6 regulated utilities, which compares 90% of earnings. A quick synopsis is below, from their latest Investors Presentation:

Tampa Electric

Utility Type: Vertically integrated electric utility

Regulator: Florida Public Service Commission

Regulatory Construct: 9.25% – 11.25% approved ROE (10.25% midpoint); 54% approved equity; $9.5 billion rate base; in year 2 of a 3-year rate agreement

Customers: ~827,000Generating Fuel Mix: 78% Natural Gas, 15% Solar, 7% Coal

Nova Scotia Power

Utility Type: Vertically integrated electric utility

Regulator: Nova Scotia Utility & Review Board

Regulatory Construct: 8.75% – 9.25% approved ROE (9.0% midpoint); 40% approved equity; $4.6 billion rate base; in year 1 of a 2-year rate agreement

Customers: ~541,000

Generating Fuel Mix: 44% Coal, 28% Natural Gas and Oil, 21% Renewable, 7% Petcoke

Emera Newfoundland & Labrador Holdings

Maritime Link, Utility Type: Electric High Voltage Transmission, ~310 miles

Regulator: Nova Scotia Utility & Review Board

Regulatory Construct: 8.75% – 9.25% approved ROE; 30% approved equity; $1.7 billion rate base

Labrador Island Link, Utility Type: Electric High Voltage Transmission, ~685 miles

Regulator: Newfoundland and Labrador Board of Commissioners of Public Utilities

Regulatory Construct: 8.50% approved ROE; $740 million equity investment

Peoples Gas

Utility Type: Natural gas distribution system

Regulator: Florida Public Service Commission

Regulatory Construct: 8.9% – 11.0% approved ROE (10.15% midpoint); 54.7% approved equity; $1.9 billion rate base

Customers: ~468,000

New Mexico Gas

Utility Type: Natural gas transmission & distribution system

Regulator: New Mexico Public Regulation Commission

Regulatory Construct: 9.375% approved ROE; 52% approved equity; $0.8 billion rate base

Customers: ~545,000

Emera Caribbean Utility Companies: Barbados Light & Power and Grand Bahama Power

Utility Types: Vertically integrated electric utilities

Regulators: BLPC: Fair Trade Commission, GBPC: The Grand Bahama Port Authority

Regulatory Construct: BLPC: 10.0% ROE on $420 million equity rate base; GBPC: 8.37% ROE on $275 million equity rate base

Customers: ~152,000Generating Fuel Mix: 97% Oil-fired, 3% Renewables

In addition, Emera operates natural gas transmission pipelines in Eastern Canada and Florida along with a hydro-electric with pumped storage power generating facility in Massachusetts. Overall, Emera has over $15 billion in regulated rate base assets, services 2.5 million customers, and offers a diverse utility footprint.

According to Regulatory Research Associates, a service of S&P Global (SPGI), Emera operates in very attractive regulatory environments. As the ultimate gatekeeper of utility profits, individual regulatory agencies possess immense power over the ability of utilities to reward shareholders. As readers know, RRA regulatory environment ratings are an important due diligence factor when evaluating utilities and their investment desirability. In a recent SA article

American Electric Power (AEP): Attractive Transmission Assets, I offered the most recent listing of states by RRA regulatory ratings. S&P Global recently published its annual North American Regulated Utilities 2023 report and on pg. 28-29 lists their Canada Regulatory Jurisdiction Assessment, as of Nov 2023, highlighting a Nova Scotia downgrade. The list below outlines each state’s ratings along with the percentage of EMRAF regulated asset base within that state:

Florida: 58% of total regulated rate base; RRA rating – Above Average

Nova Scotia: 22% of total regulated rate base; RRA rating – Adequate (lowest of 5 groups, comparable to Below Average in the US)

Newfoundland, Labrador: 12% of total regulated rate base; RRA rating – Highly Credit Supportive (comparable to Above Average)

New Mexico: 4% of total regulated rate base; RRA rating – Below Average

Caribbean: 4% of total regulated rate base; RRA rating- Average

Combining these profiles, 70% of Emera’s regulated asset base is overseen by regulators grouped as Above Average, 4% as Average, and 26% as Below Average. The Nova Scotia regulatory environment is improving after a knee-jerk reaction in 2022 to the common utility theme of escalating ratepayer costs. The reactionary 40% equity ratio is quite punitive and another rate review due this year with the expectation of this ratio being raised.

For investors who don’t appreciate the impact of investing in the best regulatory environment, Emera earns 63% more on every dollar of regulated rate base asset in Florida than the identical dollar rate base asset in Nova Scotia. In the latest IP linked above, EMRAF calculates that $100 rate base asset in FL earns the company a $5.51 return while $100 asset in Nova Scotia earns a $3.38 return. Even Below Average rated New Mexico allows EMRAF to earn $4.88 on a $100 rate base asset. It’s not rocket science to realize that 75% of EMRAF capital investments from 2024 to 2027 will be spent in Florida through its Tampa Electric and Peoples Gas.

Based on data from marketscreener.com and supplied by S&P Global, Emera is currently valued at a 2023 estimated PE of 15.8x, based on 2023 earnings of USD$2.30 and currently yields 5.7% based on 2023 distribution of $2.07 and a stock price of USD$36.20 (Cnd$49.60). The table below lists Canadian and USD earnings and dividend estimates for 2022 to 2025. The impact of the punitive rate actions by Nova Scotia regulators is obvious in the below table. If the 40% equity ratio is raised this year, 2025 earnings estimates could get a boost.

Morningstar rates Emera as 4 Stars and the stock currently trades 10% below its Fair Value of USD$40 (Cnd$54). M* calculates EMRAF P/E at 16.1x and offers the following historic chart of P/E comparison of EMRAF to Duke Energy (DUK) and NextEra Energy (NEE), two popular utilities also with exposure to the Florida regulatory environment. As shown from the Morningstar graphic below, Emera is on the low end of its historic P/E range going back to 2014.

Morningstar’s “Bulls Say – Bears Say” offers a concise recap of both sides of the investment analysis and their recent review of Emera is no different:

Bulls Say

1. The move toward regulated operations drives rate base and earnings growth certainty.

2. Emera earns regulated returns in many different states and provinces, protecting its earnings from the impact of one adverse regulatory ruling.

3. The company’s Florida utility operates in a highly constructive regulatory environment with above average growth opportunities.

Bears Say

1. The company’s aggressive investment plan increases regulatory risk, particularly in Nova Scotia.

2. The company’s no-moat energy services unit brings some commodity risk and cash flow uncertainty to its regulated portfolio.

3. As with all utilities, rising interest rates will raise financing costs and could make the dividend less attractive for income investors.

While in the long term, I believe the utility regulatory environment is the single-most significant factor for utility investors, there are risks which should be monitored. Emera excels in its regulatory environment attributes, but the politicization of rate setting in Nova Scotia has added a concern. As shown above, the reduction in allowed returns combined with a slashed ratio of allowed investment equity negatively impacts EMRAF’s profitability. The most obvious and anticipated result is the reduction in earnings in 2023 and beyond vs 2022. In response, management has reduced capital investments in Nova Scotia. The Nova Scotia Utility & Review Board is expected to review their 2022 rate ruling this year. The risk to investors is the Board does not alter its allowed return formula and the 22% of EMRAF’s rate base assets in Nova Scotia continues to underperform. However, I believe this outcome is already a factor in earnings estimates and share prices. If the allowed return formula improves in Nova Scotia, this could offer a positive turn for share price valuations as earnings prospects could improve as well. As with most all utility selections over the short-term, there is a chance the falling-competitive-interest-rate stock price rally, which began in October and November of last year, could fizzle with any rate increases by the Fed.

Emera stock price has rebounded from its lows from last October and November, along with its peer utilities, as competitive interest rates have eased. According to dividendchannel.com total return calculator, over the past 5 years, EMRAF total return with dividends reinvested has generated 6.11% annually, in line with S&P Utility ETF (XLU) total annual return of 6.37%. From a yield vantage point, Emera’s 5.7% current and 5.9% forward estimated 2024 yield is on the higher side of electric utility peers. The current yield should more than offset investor objections to a below-utility-average anticipated dividend growth rate. It is also noteworthy the distribution is paid in Canadian Dollars that if the US Dollar declines in value against the Canadian Dollar, the after-exchange cash dividend payment will increase, adding to EMRAF’s already attractive yield.

Based on its regulatory environment, current yield, and valuation, investors should consider adding Emera to their utility portfolio. The yield is substantially above the average for the sector and the current P/E valuation has been on the low end for the past 5 years. According to SA calculations, EMRAF’s average yield over the past 4 years is 4.71% vs 3.43% for the utility sector, making the current 5.7% yield extremely attractive.

If I was not a shareholder, the current price, yield, and potential total return is sufficiently attractive to institute a position. I expect a rocky first half of 2024 with a strong potential for market dips over the next few months. If the market falls between now and the 3rd qtr., I will happily add more EMRAF with any dip below $34, making Emera an overweight investment in my utility portfolio. I view buying Emera at the current price as an attractive long-term investment for both income and growth, and any additional price decline as a long-term bargain.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.