Black Hills Corporation: Dividend King, Decade High Yield Near 5% (NYSE:BKH)

A Dividend King Trading at a discount to its per share dividend growth rate

Seeking high-yield alternatives before the Fed moves to lower interest rates, many investors are looking to the beaten-down Utilities sector. While this is a sector that operates heavily on debt and share dilution, their cash flow streams are maybe second only to taxes as far as the reliability of income is concerned. There are only a handful of Utility companies that are in the Dividend King category, with dividend growth of 50 years or more. Black Hills Corporation (NYSE:BKH) is one of those.

Amongst the group of Dividend King Utility companies, you will find an overweighting of water utility companies and only a few gas and electric companies. These companies usually have a share price growth rate that exceeds their growth in dividends per share. Below we can see a sampling of a water utility, American States Water Company (AWR), and a fellow Electric utility, Consolidated Edison, Inc. (ED). Both are also Dividend Kings and both trade at the aforementioned premium.

We can see that Black Hills trades at a discount growth rate to the dividend per share growth rate contrarily. This is indicative of value amongst the group. My thesis is Black Hills is a buy and probably the cheapest utility name you will find amongst the Dividend King Utility group. With 52 years of Dividend growth, this company is a great alternative to long-duration fixed-income products of a similar yield.

What they do

Black Hills Corporation is an electric and gas Dividend King out of South Dakota. The company’s electric utilities serve the states of Colorado, Montana, South Dakota, and Wyoming with 220,000 customers. The gas segment serves Arkansas, Colorado, Iowa, Kansas, Nebraska, and Wyoming. They have nearly 5,000 miles of gas distribution with 1,107,000 customers.

This company is best thought of as serving the middle states of America.

Dividend yield comparisons amongst the Dividend King Utilities

Above are a few of the dividend king utility names pitted against Black Hills Corporation. The dividend yield is superior to the group with a middle-of-the-pack growth rate of 5.31% over the trailing 5 years. The dividend growth rate for the Black Hills tracks forward guidance of the expected per-share GAAP earnings per share growth rate. In any good Dividend King or Aristocrat, we typically want to see dividend bumps in line with earnings and free cash flow growth rates.

While Black Hills currently has a payout ratio that is a tad above 60% of earnings, this falls within the company payout ratio threshold goals of 55-65% expressed in their most recent Q3 highlights.

Heat check

At 40% off the high, this has normally been a company that has a share price that tracks the dividend per share growth rate. We can see below that the rate of price appreciation got ahead of the dividend per share growth rate but we have now gotten back into the territory of realism:

With the current price drop, there is now a nice gap between where the share price has gone when compared to EPS, revenue, and dividend per share growth rates on a 10-year basis.

How rare is the yield?

Entering at a near 5% yield is the highest entry point since the early 2010s. This is a rare opportunity for an electric and gas utility to pay qualified dividends if held long-term. Let’s take a look at the positives and negatives of the company’s financials to see how we got here.

Revenue sources

The most recent 10 K for Black Hills Corporation reported their full 2022 numbers. According to the above, the revenue breakdown looks like the following:

• Retail electric utilities: 28.9%.
• Retail gas utilities: 56.9%.
• Gas transportation: 6.7%.
• Electric wholesale: 1.7%.
• Market off-system sales of gas and electric: 1.9%.
• Transmission of gas and electric: 3.2%.

As we can see, the company is heavily weighted towards retail consumer exposure at 85.8% of revenue.

Most recent quarterly results from November

The company had a beat of .16 cents a share in the last reporting period over analyst estimates.

The company has had 4 upward revisions in the past 90 days. Q1 tends to be the company’s best-performing quarter with uneven utility usage throughout the year in this 4 season territory of the United States.

From Black Hills 10-K:

Seasonal Variations of Business. Our Electric Utilities are seasonal businesses and weather patterns may impact their operating performance. Demand for electricity is sensitive to seasonal cooling, heating, and industrial load requirements, as well as market price. In particular, cooling demand is often greater in the summer, and heating demand is often greater in the winter.

If we remember from running through the revenue exposure, it is more weighted towards gas at 56.9% than electric at 28.9%. Thus we can expect the cooler months/financial quarters to be the highest revenue-generating quarters for the company.

Upcoming earnings

With Q4 earnings coming up on February 7th, the company has had 4 positive EPS revisions in the last 90 days. Looking at quarter-over-quarter trends, Q4 is typically the second most lucrative quarter next to Q1, tracking the seasonality encompassed in the gas segment. The positive revisions foretell an expected uptick in gas usage, possibly due to both increased restaurant/ F&B usage and general retail household usage.

The dividend per share was also recently increased on the company’s Jan. declaration 4% to $.65 a share for the quarter now making this a forward yield of 5.12%. The Dividend King trend looks to continue.

Balance sheet

We can see in the above example that Black Hills, and other utilities, have balance sheets similar to REITs. They borrow and sell shares for expansion while paying out a large portion of cash flow in dividends. All three, revenue, shares outstanding, and long-term debt correlate to one another on upward trend lines. Warren Buffett likes utilities and has admitted that they are a heavily indebted business, but also heavily regulated and form a social pact with local governments since the two need each other to succeed. The debt they take on is often non-recourse and is based on cash flow.

The bad

Like other utilities and debt-burdened businesses, rising rates have not been kind.

We can see more than doubling in interest rate expenses in the last 10 years. this has been dampened some by interest income from cash on the balance sheet. Let’s see how the rise in interest expense compares to LT debt growth and EBITDA growth over this same period:

We can see that debt has grown 215% and EBITDA only 64% in nominal dollar terms the company produces $1 of cash flow for every $6.58 of debt created in this period. The company was flattening out its debt line until the Covid era and the debt witnessed an upward spike:

Cash on hand and cash flows

The company’s cash and short-term investments have a spike and a lull period every 5 years since 2000. Cash from operations tends to recede slightly after the spike periods indicating the need to reinvest cash through CAPEX cycles. Cash from operations traces up as cash recedes. The huge dip during Covid also corresponds with the large CAPEX period that spiked going into 2020.

Two things happened in this period. A shutdown of many utility-using businesses, like restaurants and entertainment locations, combined with a population influx from states like California and New York which had more serious Covid lockdowns. This created both a cash crunch and a need to increase capacity with population growth. It also increased debt on the balance sheet at a faster rate than where we sit today.

Valuation

As the company is trading near book value and a low P/E GAAP FWD ratio, this passes the initial eyeball test for a Benjamin “Graham Number” fair value. This is the price at which the price to earnings X price to book does not cross Graham’s magic number of 22.5. It is a very appropriate number for companies that have a significant amount of tangible assets for which utility companies qualify. Let’s observe:

SQRT 22.5 X BV X 2024 EPS estimates = SQRT 22.5 x 3.88 x 46.58= $63.76.

With the current price at $52/share, Black Hills is trading at about 81% of fair value. There is also a 36.7% gap between the 10-year EPS growth rate and the per-share price growth rate. As Black Hills previously traced the EPS growth rate with fair accuracy, even a 19% upside to intrinsic value would still put the price below its 10-year earnings growth rate. A fair margin of safety.

Company growth rate trajectories

The 4-6% growth target is in line with the trailing 5-year dividend CAGR. The $700 million CAPEX target, the most pertinent number to free cash flow, is slightly above recent 10-year trends:

Risks

The higher for longer interest rate narrative. Highly debt-reliant sectors like utilities, telecoms, and REITs could face more extreme choices between expansion through debt and expansion through share dilution. The longer debt remains expensive, the more likely we as shareholders are to be diluted. Wildfires are always a risk to utilities as well. Luckily the company does not operate in the highest liability state, California, but Colorado is in the top 5 states of highest wildfire risk.

As the Q3 presentation has a slide regarding wildfire mitigation efforts, this expression also verifies the risk in this area:

Renewables

While the company’s future CAPEX growth plan includes adding renewable sources of energy, namely wind, solar, and battery sources, this is also a risk from an investor perspective. The unknown build out could create CAPEX overruns and damage to cash flow. Positive for the environment, but questionable whether the execution goes as smoothly as planned.

Summary

There are a few great Dividend King utility companies with an overweighting towards water utilities. Electric and gas is one of the more favorable sectors for long-term dividend growth and great alternatives to bonds. Interest rates continue to hamper growth in the sector, but you never get a good deal without a hiccup. 20-year dividend high. Buy.