About the Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks.

Josh manages of DividendInvestor's model dividend portfolios, the Dividend Harvest and the Dividend Builder. Josh joined Morningstar in 2000 as an automotive and industrial stock analyst. After leaving in 2003 to join UBS Investment Bank as an equity research associate, he returned to Morningstar in 2004 to develop DividendInvestor.

Peters holds a BA in economics and history from the University of Minnesota Duluth and is a CFA charterholder. He is also the author of a book, The Ultimate Dividend Playbook, which was released by John Wiley & Sons in January 2008.

Investment Strategy

The goal of the Builder Portfolio is to earn annual returns of 11% - 13% over any three-to-five year rolling time horizon. We further seek to minimize risk, as defined by the probability of a permanent loss of capital. For our portfolio as a whole, this goal is composed of:

2% - 4% current yield
8% - 10% annual income growth

The goal of the Harvest Portfolio is to earn annual returns of 9% - 11% over any three-to-five year rolling time horizon. We further seek to minimize risk, as defined by the probability of a permanent loss of capital. For our portfolio as a whole, this goal is composed of:

6% - 8% current yield
2% - 4% annual income growth

About Josh Joshs Photo
Josh Peters, CFA
Equities Strategist and Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks, and manager of DividendInvestor's model dividend portfolios, the Dividend Harvest and the Dividend Builder.
Featured Posts
Thoughts on Intel -- The Week in Dividends, 2014-11-21

There was very little news for our portfolio holdings this week. Last week we indicated that our fair value estimate for Builder holding Procter & Gamble PG would rise by $1 a share in light of what we learned at last week's analyst event (including the upcoming sale of Duracell). This week, we made that move official--our fair value estimate for P&G is now $94 a share, and I continue to view the stock as a buy (particularly when its current yield is 3.0% or better).

We also raised our fair value estimate for Harvest holding Southern Company SO by $1 a share to $46 due to several factors noted in the updated analyst report included below. The stock still looks mildly overvalued at present--like almost all of its regulated utility peers--but it remains one of my favorites in the sector for the long haul.

Perhaps the most notable news item of the week came from former Builder holding Intel INTC. On Thursday, the company announced a 6.7% dividend increase to take effect in the first quarter of 2015 after skipping hikes during 2013 and 2014. This completes what has been a tough experience from the sidelines: Not only did I sell the stock just before it started a march from $25 to $36, but my primary reason for selling--the pause in dividend growth--did not stay valid for very long.

We did make money while we owned Intel; our total return was 20.9% over 17 months. It's not like my decision to sell (which merely led to foregone profits) was the same as taking a short position (which would have produced a large actual loss). Of course, the subsequent performance of the stock--and, now, the company itself--can't help but sting a bit. I pay very close attention to the signals sent by dividends, and over time I have observed that when a pattern of dividend growth comes to a halt, the risk of something worse, such as a dividend cut, goes up. However, can't help but think that these signals are more effective, or at least easier to understand, when they come from traditional high-quality, high-payout areas of the market--utilities, staples, and so on. In technology, a field that faces greater cyclicality and far greater technological uncertainties than our usual fare, it's harder to develop a high level of confidence in a dividend-focused call.

In the end, the best anyone can hope for in any investment process is that it will work more often than it doesn't. Since January 2005 I've bought my share of losers and failed to own lots of winners that had above-average yields, yet our imperfect process has still produced superior risk-adjusted total returns.

As for Intel itself, the resumption of dividend growth--particularly in the context of improved earnings rather than just a rising payout ratio--is fairly interpreted as a positive signal. However, we think investors have overreacted to Intel's recent success: Our fair value estimate is currently $26 a share, up only a dollar since I sold the Builder's shares. (For reference, the stock closed Friday at $35.59.) I've included our most recent analyst note for Intel at the end of this week's research roundup.

Naturally, there is some chance that our appraisal is way behind the curve. I haven't ruled out the tech sector in general--or even Intel in particular--as potential candidates for our portfolios given the right set of circumstances in the future. But we've got to know what we own, and no matter what Intel's dividend yield happens to be, it's not in the same league as a Johnson & Johnson JNJ or a Realty Income O. Among high-payout stocks, it's the tried and true that generally deliver the most reliable results for investors.

Best regards,

Josh Peters, CFA
Director of Equity-Income Strategy
Editor, Morningstar DividendInvestor

Disclosure: I own the following stocks in my personal portfolio: AEP, APU, CLX, CVX, EMR, GE, GIS, GSK, HCN, JNJ, KO, KRFT, MCD, MMP, NGG, O, PAYX, PEG, PG, PM, RCI, RDS.B, SE, SEP, SO, UL, UPS, WFC, XEL.

News and Research for Builder and Harvest Portfolio Holdings

AWS-3 Bidding Heats Up; We Remain Cautious on Valuations
Industry Note 11/19/2014 | Michael Hodel, CFA

Demand in the Federal Communications Commission's AWS-3 wireless spectrum auction has surpassed our expectations, producing winning bids totaling more than $18 billion through the first 16 rounds. Bidding over the past day has pushed prices well beyond the reserve placed on the paired spectrum bands offered. Bidding for the unpaired, uplink-only bands has been subdued. Share prices of all the major carriers are lower on this news, especially T-Mobile, the firm that can least afford to get wrapped up in a bidding war. We believe this reaction makes sense, as we question the carriers' ability to collectively earn attractive returns on incremental spectrum investments. If AWS-3 bidding continues to charge forward, we are likely to reduce our fair value estimates for the winning bidders.

Conversely, DISH Network's shares are up sharply on the view that the AWS-3 auction results reflect directly on the value of the firm's spectrum holdings. Demand for AWS-3 certainly increases the likelihood that DISH is able to extract a high valuation for its spectrum, and we will probably increase our fair value estimate in light of the auction results. However, we continue to believe that a conservative approach to valuing DISH's spectrum holdings makes sense and that the stock is significantly overvalued. DISH's existing holdings face issues that limit their usefulness on a stand-alone basis. We suspect that the carriers are more likely to favor deploying unused spectrum, refarming spectrum from old to new technologies, and targeting spectrum available at auction (including AWS-3) before working with DISH. Without a clear path to creating value with its wireless spectrum and build out deadlines looming, we question DISH's ability to fully extract the value of its holdings.

In addition, the AWS-3 spectrum benefits from its congruity with the AWS-1 band; deploying AWS-3 spectrum, once it is cleared, should be relatively easy for firms currently using AWS-1. Verizon and T-Mobile use AWS-1 heavily in their networks; AT&T uses the band, but to a lesser extent. Also, the telecom industry sits at a turbulent juncture with regulators, with network neutrality, major merger reviews, and the broadcast spectrum auction top of mind. A desire to placate regulators may prod the carriers, AT&T and Verizon in particular, to bid more aggressively than they otherwise would. Finally, we expect that DISH is also an active participant in the AWS-3 auction. To the extent that DISH's bidding activity pushes up the final prices paid, using AWS-3 to value the firm's other spectrum holdings becomes an exercise in circular logic. Said differently, we already know that DISH thinks very highly of the value of its current holdings, so bidding aggressively essentially amounts to talking its book.

More generally, we would note that recent bidding activity has been heavily concentrated in the largest markets. New York, Los Angeles, Chicago, San Francisco, and Washington/Baltimore account for about half of the total auction proceeds generated thus far but contain less than one fourth of the U.S. population. We believe the carriers' minimal ability to price-discriminate geographically severely restricts their ability to earn decent returns on these licenses in particular.

Finally, recall that Verizon paid $0.69 per MHz POP for free and clear AWS-1 spectrum in 2011. The firm has been able to put this spectrum to use very quickly, enabling its network performance to remain very strong. AWS-3 bidding on paired licenses has already reached a nationwide average of $1.15 per MHz POP. This valuation seems extremely rich to us, especially given that it will take several years to clear current government entities from the AWS-3 band.

BAI Retail Deliver Conference Shows Future of Bank Branch and Omnichannel Delivery
Industry Note 11/17/2014 | Dan Werner  

Attending the BAI Retail Delivery conference last week largely confirmed our view that banks are looking for the most cost-effective ways to deliver products and services through smaller branches and more digital offerings. The role of the physical bank branch and its future as the primary delivery channel of products and services continues to face change. While the traditional branch will continue to serve as a very public and important retail delivery channel, banking, like other retailers of products and services, is moving towards omnichannel delivery through the use of self-serve, digital devices, which are generally cheaper to provide on a per-transaction basis than via a teller at a branch. Our view that PNC Financial and Wells Fargo are leaders in this transformation toward digital delivery has not changed.

Some of the struggles that bankers have with this shift, especially the small banks, relate to how to pay for these new delivery channels while providing a positive and cost-effective customer experience. While there is no one-size-fits-all answer, each of the bankers at the conference was struggling with how to provide a differentiating positive customer experience from a financial, cultural, marketing, and staffing perspective.

In addition to PNC Financial and Wells Fargo, many other banks have been undergoing these changes to their retail delivery format over the past couple of years. Also, any perceived gap in the haves versus have-nots among the large banks is narrowing. In our January Financial Services Observer ("Traditional Bank Branches Under Siege: The Rise of Digital Banking"), we noted that the U.S. subsidiary of Royal Bank of Scotland lagged behind in this transformation. Since then, that subsidiary has been spun off from Royal Bank of Scotland and now trades as Citizens Financial Group. The management of Citizens has already indicated its commitment to optimize its distribution model. Ultimately, we think the banks that can provide positive customer experiences by connecting with retail customers and providing solutions to make their lives easier are the ones that will succeed in this transformation.

Procter & Gamble PG
Analyst Note 11/18/2014 | Erin Lash, CFA

We think P&G’s reignited focus on winning with innovation may be gaining traction, and we now perceive the firm’s moat trend as stable. We aren’t changing our wide moat, but we’re raising our fair value estimate to $94 from $93 to account for the sale of Duracell. We think the shares are worth a look, trading at a discount to our valuation.

P&G is making strides to enhance its share position, particularly in two of its largest categories, diapers and laundry. For one, despite operating as the number-two player in the U.S. diaper market for the past 20 years, after new product launches and efforts to get in front of new moms early on with increased sampling in hospitals, Pampers (P&G’s largest brand with $10 billion in annual sales) has overtaken Huggies (a Kimberly-Clark brand) and now controls around 38% share of the market, about 300 basis points above its leading competitor. Further, in U.S. laundry, P&G now controls about 62% of the market, up from less than 60% the last several years, partly reflecting the success of its single-dose laundry pod launch. While it sells at a 20% premium to base Tide, this offering is even winning with dollar-store customers because of the convenience it affords (it is easier to take a pod or two to the laundromat than a jug of liquid detergent). We think this shows consumers will pay up for a product when they perceive added value.

Efforts to remove costs from its operations and leverage its scale are also stabilizing its competitive position. For one, the extension of common manufacturing platforms globally is proving advantageous for its diaper business, a product that had been manufactured in a disparate form (using different materials around the world), which inherently limited the negotiating leverage it could garner over suppliers. However, by streamlining its manufacturing and using the same inputs on a global basis, we expect it to exploit its purchasing leverage and ultimately enhance its cost edge.

Procter & Gamble: Investment Thesis 11/18/2014
Procter & Gamble is working to right its ship. The firm previously entered too many new markets (particularly emerging markets, where competitors already have a leg up) too quickly, and new products failed to resonate with consumers, as evidenced by its languishing market share position. However, P&G's announcement that it intends to shed 90-100 brands--more than half of its existing brand portfolio, which in aggregate posted a 3% sales decline and a 16% profit reduction the past three years--indicates it is parting ways with its former self, looking to become a more nimble and responsive player in the global consumer products arena. We view this as a particularly important trait given the stagnant growth emanating from developed markets and the slowing prospects from emerging regions.

Even a slimmed-down version of the leading global household and personal care firm will still carry significant clout with retailers, and we think these actions will only enhance P&G's brand intangible asset and its cost advantage, which together form the basis for our wide moat. The 70-80 brands it will keep (including 23 that generate $1 billion-$10 billion in annual sales, and another 14 that account for $500 million-$1 billion in sales each year) already account for 90% of the firm’s top line and 95% of its profits. As such, we don't anticipate P&G will sacrifice its scale edge but will be able to better focus its resources (both personnel and financial) on its highest-return opportunities.

These actions build on the firm's $10 billion cost-saving initiative designed to lower costs through reduced overhead, lower material costs from product design and formulation efficiencies, and increased manufacturing and marketing productivity. Overall, we think the combination of these efforts will enable P&G to up its core brand spending (behind product innovation and marketing support), which is critical given the ultra-competitive landscape in which it plays, while at the same time driving improved profitability. We forecast margin expansion at the gross (up around 200 basis points to 51%) and operating income line (up 350 basis points to 23%) over our 10-year explicit forecast.

Procter & Gamble: Economic Moat 11/18/2014
P&G is the leading consumer product manufacturer in the world, with more than $80 billion in annual sales. Its wide moat derives from the economies of scale that result from its portfolio of leading brands, 23 of which generate more than $1 billion in revenue per year and another 14 of which generate between $500 million and $1 billion in sales annually. Given the dominant market positions P&G maintains in its categories (over 30% of baby care, 70% of blades and razors, more than 30% of feminine protection, and in excess of 25% of fabric care), we contend that retailers rely on P&G's products to drive traffic in their stores. Further, the size and scale P&G has amassed over many years enable the firm to realize a lower unit cost than its smaller peers, resulting in a cost advantage. From our perspective, P&G supports its competitive advantages by investing in research and development ($2 billion annually or 2.5% of sales) and marketing ($9 billion each year or 11% of sales) for core brands (which is comparable to the approximately 2% and 11%-13% of sales spent on research and development and marketing, respectively, by wide-moat peers Colgate and Unilever).

P&G's recent announcement that it intends to shed 90-100 brands--more than half of its existing brand portfolio, which in aggregate posted a 3% sales decline and a 16% profit reduction the past three years--indicates it is parting ways with its former self, looking to become a more nimble and responsive player in the global consumer products arena. Even a slimmed-down version of the leading global household and personal care firm will still carry significant clout with retailers, and we think these actions will support P&G's brand intangible asset and its cost advantage. The 70-80 brands it will keep already account for 90% of the firm’s top line and 95% of its profits. As such, we don't anticipate P&G to sacrifice its scale edge but will be able to better focus its resources (both personnel and financial) on its highest-return opportunities. Overall, we forecast returns on invested capital (including goodwill but excluding excess cash) to average 16% over our 10-year explicit forecast, well in excess of our 7.4% cost of capital, solidifying our take that P&G maintains a wide economic moat.

Procter & Gamble: Valuation 11/18/2014
After incorporating the impact of the Duracell sale to wide-moat Berkshire Hathaway for its $4.7 billion in P&G shares (52.8 million shares, a transaction that is slated to take place in the second half of calendar 2015), we're taking fair value up by $1, to $94 per share. P&G expects to incur $0.28 per share in a goodwill impairment charge and is set to inject $1.8 billion of cash into the battery business before the close, which lowers the deal value to $2.9 billion or 1.3 times fiscal 2014 sales and 7 times fiscal 2014 adjusted EBITDA. Our long-term expectations for P&G's consolidated operations (annual top-line growth above 4% and nearly 23% operating margins) remain in place. This implies forward fiscal 2015 price/adjusted earnings of 21 times, enterprise value/adjusted EBITDA of 15 times, and a free cash flow yield of 4%. We contend that the decision to shed more than half of its brands over the next two years stands to enhance the firm's focus ion the highest-return opportunities. Deteriorating economic conditions in the U.S. and Europe combined with moderating growth in emerging markets like China will constrain P&G's growth prospects over the near term, which is reflected in our sales growth of less than 2% in fiscal 2015 and just north of 3% in fiscal 2016. Over the long term, we continue to expect top-line growth above 4% on average annually. Globally, P&G's categories grow roughly 3% annually, so to reach the 4% annual sales growth pace we've modeled, the company would have to be growing 1%-2% faster than the markets and categories in which it competes, which we think is achievable, particularly in light of recent strategic efforts. While sales growth in the U.S. and Europe may be flat or up only 1%, the company's sales in developing markets are growing at 6%-8% annually. The firm has growth opportunities for its brands in many overseas markets, and in developed markets it remains the share leader in many of its categories. Even though we're encouraged P&G is realizing some margin improvement from its ambitious initiative to shave $10 billion from its cost structure, we ultimately think the firm will need to reinvest a portion of these savings to maintain its competitive positioning. Our forecast calls for operating margins of 20.1% in fiscal 2015 (compared with 19.4% in fiscal 2014), and we expect operating margins to improve to nearly 23%% by the end of our 10-year explicit forecast.

Procter & Gamble: Risk 11/18/2014
Like others, P&G has fallen victim to weak and volatile consumer spending combined with persistent cost inflation that has yet to fully abate. At the same time, promotional spending over the past several years has conditioned consumers to expect lower prices, and lackluster innovation has, in some instances, failed to prompt consumers to pay up for its new products. Further, with more than 60% of its sales derived outside the U.S., P&G is exposed to foreign exchange rate fluctuations, which could have a negative impact on sales and profitability.

Slowing growth rates around the world, competitive pricing, and unfavorable foreign exchange trends have played a part in Procter & Gamble's woes, but we think the problems run deeper, as the firm might have overextended itself in its endeavors to build out its product portfolio and geographic footprint. While P&G was slow to react, management has responded with a massive $10 billion cost-saving initiative to dramatically reduce head count and ultimately free up funds to reinvest in its business. More recently, the firm has followed these cost cuts with plans to halve its brand portfolio to better focus its resources, which we view positively.

From a category perspective, despite some of the gains the firm is realizing within the U.S. diaper and laundry categories, beauty remains a challenge, as organic sales remain at the level of a year ago. Management has noted that Olay in particular continues to struggle, although Pantene appears to be gaining some traction, posting mid-single-digit organic sales in the first three months of its fiscal year. Despite this, we suspect the performance in this category could prove lumpy given the fierce competitive dynamics of the U.S. hair care space, and it will take a few more quarters until we can get a sense whether this improvement is sustainable.

Southern Company SO
Analyst Note 11/16/2014 | Mark Barnett

We reaffirm our $45 per share fair value estimate and stable narrow moat rating for Southern Company after discussing its key construction projects and growth outlook with senior management at the Edison Electric Institute Financial Conference in Dallas. [Editor's note: Our fair value estimate for Southern was raised $1 to $46 on Nov. 19; see below for details.]

Southern's major construction projects--the Kemper coal gasification plant, Vogtle nuclear units 3 & 4, and a massive environmental overhaul--still hold uncertainties for investors. Persistent cost overruns at Kemper remain an overhang that won't be resolved until a prudency review in 2016. However, we think the market's chief concern is cost overruns at the Vogtle project. We think these fears are unfounded despite projected delays and extra costs at SCANA's similar project.

Realized and potential cost overruns at Kemper and Vogtle stem from different roots. Kemper suffered from engineering and management oversights. Third-party E&C capabilities and contractor errors have been the problem at Vogtle and SCANA's project. Southern management says it has fixed-cost contracts for the balance of the Vogtle work. We also think Georgia regulators will be more amenable to incorporating Vogtle cost overruns in customer rates. In our fair value estimate we assume shareholders bear $200 million for additional Kemper costs and $500 million for Vogtle cost overruns.

Management also acknowledged a generally disappointing post-recession recovery in power usage. Industrial demand has been resilient, but residential demand has lagged forecasts, weighing on Southern's long-term growth prospects. Regional household income weakness and a predominance of multifamily homes in new construction play a major role.

Southern plans to invest roughly $3.2 billion for environmental compliance through 2016, but that figure would expand significantly with stringent coal ash or carbon emissions regulation.

Southern Company: Investment Thesis 11/19/2014
Southern's total return proposition remains appealing for patient investors in a world of few decent income alternatives. This giant Southeast utility enjoys some of the best regulation in the United States and strong, consistent regulatory relationships in its key service territories of Alabama and Georgia. The company is in the middle of a huge investment program aimed at phasing out or retrofitting its massive coal fleet, building a low-carbon coal unit in Mississippi, and constructing the first new nuclear plant in the U.S. (in Georgia) after a more than 30-year freeze.

While regulatory risk is high--as evidenced by ongoing cost disputes in Mississippi and cost overruns at Vogtle's peer nuclear project in South Carolina--earnings and cash flow growth should improve as expenditures close to rates, driving just under 4% earnings and dividend growth through 2018. Although economic growth in the firm's four service territories might not remain above average, capital investment remains the primary engine of our growth forecast, and much of it closes to cash returns annually, keeping cash lag below many peers'.

Southern has more upside to economic improvement than most peers and has traditionally traded at a premium to the sector. While that premium has shrunk with uncertainty around Kemper and Vogtle, investors shouldn't underestimate Southern's constructive regulatory structure, despite above-average recovery risk during this investment cycle. Favorable and supportive regulation is a key driver behind the company's huge construction program and above-average returns.

Southern Company: Economic Moat 11/19/2014

We think Southern's narrow economic moat arises from the nature of the regulatory compact between its four utilities and state regulators. In return for its allowed monopoly in its service territory, regulators allow the utilities to recover their investments in the system with a reasonable return on and of their capital. The company's transmission and distribution assets would be extremely difficult and costly to replicate, which in the U.S. has traditionally served to justify its monopoly. These factors are balanced by the effective cap on returns provided by regulation.

Among its peers, Southern's regulatory environment stands out as the strongest and is supported by above-average economic fundamentals in its key regions as well. These factors contribute to the premium returns Southern has earned and have led to a constructive working relationship with regulators, the most critical component of a regulated utility's moat. We expect returns on invested capital to remain at a modest but consistent spread above Southern's cost of capital for the foreseeable future.

Southern Company: Valuation 11/19/2014
We are raising our fair value estimate to $46 per share from $45 to account for the time value of money since our last update and incorporating third-quarter results, the increase in Kemper charges, management's new capital expenditure guidance through 2016, and updates to our power demand forecast. We continue to include a 75% chance that Southern settles with Chicago Bridge & Iron on the Vogtle cost dispute, assuming shareholders could bear roughly $300 million in a settlement. We also include an incremental $200 million in cost overruns at Kemper and $200 million in owners' costs at Vogtle. However, it's possible that Southern could pass any settlement costs to customers or win a fully litigated case in court, neutralizing the impact on investors. Year-to-date usage strength has been strong due to favorable weather, which could continue with a cold winter, bringing in extra cash above our forecast. Our forecast for total capital investment through 2018 is roughly $24 billion and incorporates expenditures to meet coal plant emission limits in the federal air toxics rule and revised costs for the Kemper plant and Vogtle project. We forecast this spending can deliver 4.5% average annual EBIT growth through 2018. We expect Southern's regulated utilities to continue earning near its industry-leading allowed returns, though we project modest declines in allowed returns on equity through the current rate cycle. We forecast 7.9% average ROIC during the next five years. We forecast average power demand growth of just below 1.5% for Southern's utilities from a strong start to 2014 through 2018. During the next five years, we assume consolidated operating margins average 26%. We anticipate Southern will increase its dividend 3.5% annually during the next few years, largely in line with management's projections. We use an 8% cost of equity and 5.7% weighted average cost of capital in our discounted cash flow valuation.

Southern Company: Risk 11/19/2014
Although we are bullish on this company's prospects overall, some uncertainties remain, including the impact of nuclear cost overruns, possible emissions legislation, and other fossil fuel regulations. However, compliance measures could prove to be less painful to shareholders than some might expect; regulators will allow Southern to pass most of the incremental costs on to customers, preserving the firm's long-term earnings power.

The biggest threat that Southern faces is a deterioration of its regulatory relationships in its four retail service territories. Much of the company's success hinges on the relationships it has built through years of low power prices and excellent customer service. While the Kemper facility has been a financial setback, we don't believe it has any long-term impact on Southern's regulatory relationships in Mississippi and certainly not elsewhere. The risk of declining customer usage has increased, although Southern's best-in-class regulation should help mitigate the effects.

Nuclear construction expenses are approved twice a year, but there is still a risk that additional expenses might not be recovered. Cost overruns could also lead to further stranded capital at the new coal gasification plant or at the new nuclear plants, though a revised process in Georgia eases the burden of approval for new costs. If tough federal environmental regulations further raise investment needs and costs for customers, regulators might be less willing to support above-average allowed returns on equity.

Xcel Energy XEL
Analyst Note 11/17/2014 | Travis Miller

We are reaffirming our $30 fair value estimate and narrow moat and stable moat trend ratings for Xcel after discussing recent regulatory developments with senior management at the Edison Electric Institute Financial Conference in Dallas.

We think ongoing rate filings in Xcel's largest service territories, Minnesota and Colorado, are the biggest risk to earnings growth and earned returns during the next two years. On Nov. 7, Colorado's consumer advocate proposed a $68.9 million cut in Xcel's customer rates, an outcome that could keep Xcel's near-term growth at the low end of management's 4%-6% target. About $90 million of the difference between the rate cut and Xcel's proposed $136 million rate increase is proposed allowed returns on equity and capital structures. We assume regulators approve a $100 million rate increase, subject to adjustments for earnings-neutral items.

We agree with management that the Colorado regulators ultimately will decide on an allowed ROE and capital structure that effectively splits the difference between Xcel's proposed 10.35% and regulators' proposed 9.1%. Regulators recently approved a 9.82% allowed ROE for Black Hills. Management indicated it could reach a settlement before Dec. 17 when it is scheduled to file rebuttal testimony.

Management is taking several measures to protect returns and growth. In Minnesota, management plans to request a multiyear rate-setting framework, likely early next year, possibly before its ongoing rate case is decided. Xcel also is working with other utilities in Texas to improve rate structures while the state legislature is in session the first half of 2015. Xcel has plans to invest $4.5 billion in higher-return transmission projects in 2015-19, which we think is achievable with potential upside. Management is targeting 0%-2% operating cost growth in 2015-19, about half its rate in recent years.

Former Holding in the News:
Intel INTC
Analyst Note 11/21/2014 | Peter Wahlstrom, CFA

On Nov. 20 Intel hosted its investor day in Santa Clara. While we liked the incremental data and key initiative updates provided, the net impact from the briefing was not enough to alter our long-run financial model, fair value estimate of $26, or wide economic moat rating.

Intel is performing well, but we are concerned that some of the recent positive results are being extrapolated well into the future, which may not be reasonable given the cyclical nature of Intel's business.  We are favorable on the long-term growth of the data center, and view management's low-teens goal as comparable to our own assumption. The PC outlook is slightly more contentious, and management acknowledges the uncertainty of a normalized trajectory. Our internal view is that the PC is in slow decline, but will not disappear anytime soon.  Mobile is also a bit of an unknown, though recent trends are encouraging, and we like Intel's aggressive stance and willingness to reorganize to spur additional growth.

Management also provided updated full-year 2015 gross margin, R&D, and capex guidance, each of which appears reasonable and achievable based on the current market dynamics.  While some have been concerned about the potential for rising capex as the firm continues down Moore's law and/or expands its mobile capacity, so far the company has been able to keep spending fairly steady, at an estimated $10.5 billion next year. Meanwhile, as Intel slowly enters the foundry business, through selected partner relationships, this hasn't yet become a huge margin drag; management is targeting a 62% range (plus or minus 200 bps) for 2015.


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