News and Research for Dividend Select Portfolio Holdings
Air Products Posts Solid Fiscal Q3 Results and Reiterates Full-Year EPS Outlook; Raising FVE
by Krzysztof Smalec, CFA | Morningstar Research Services LLC | 08-04-22
Narrow-moat-rated Air Products reported solid fiscal third-quarter results, with adjusted EPS of $2.62 up 13% from the prior-year period. Management reiterated its full-year fiscal 2022 outlook and continues to anticipate EPS in the range of $10.20-$10.40. We've bumped up our fair value estimate to $321 from $317, mostly due to time value of money.
Air Products' fiscal third-quarter sales increased 22% year over year, driven by 5% higher volumes, 7% price attainment, and 15% higher energy cost pass-through, partially offset by a 5% currency headwind. Compared with the prior-year period, volumes were up 4% in the Americas and 2% in Asia, but down 3% in Europe due to lower hydrogen volumes in the region. Price in Europe was up 17% year over year, including a 25% increase in merchant pricing, as the company implemented significant price increases to offset higher inflation and energy costs. Management said on the call that price has more than offset cost year to date, which we think underscores Air Products' pricing power and the strength of its moat.
Air Products' fiscal third-quarter adjusted EBITDA margin compressed by 360 basis points from the prior-year period as higher energy cost pass-through, which increases revenue but not EBITDA, created a roughly 500-basis-point headwind (700 basis points in Europe).
Looking beyond fiscal 2022, we think Air Products is well positioned to capitalize on new opportunities driven by the energy transition. Last week, the company announced additional sustainability goals, including reducing its scope 3 emissions by one third by 2030, reaching net-zero carbon emissions from its operations by 2050, and spending an additional $4 billion of new capital on clean energy projects over the next five years (which would increase the total to around $15 billion by fiscal 2027). The company is developing potential low- and zero-carbon hydrogen projects in Oman, the United Kingdom, and the Netherlands.
Altria Reports in Line Q2; Headwinds Looming but Tobacco Should Remain Defensive
by Philip Gorham, CFA, FRM | Morningstar Research Services LLC | 07-31-22
Altria, the leading U.S. cigarette manufacturer, reported second-quarter results for fiscal 2022 that missed our EBIT forecasts by a whisker. Management maintained guidance for the full year, and we reiterate our $52 per share fair value estimate. Although the economic outlook is darkening in the U.S., Altria may prove to be a relatively safe shelter from commodity cost inflation, and there is upside to our valuation as at the close of business on July 28.
Second-quarter net revenue in the smokeless business fell by 0.7% year over year, in line with our expectations, but that growth figure comprised a steep decline in cigarette volume (down 11% with Marlboro down 10%), offset by price/mix. Retail volume share declined by 0.4% year over year. Altria reduced its promotional activity during the quarter, and we expect the business to take a more balanced approach in the second half of the year. U.S. cigarette industry volume is sensitive to gas prices and unemployment rates. With living expenses in the rise, there could be downward pressure on revenue. At an industry level, the share of the discount segment grew by 1.3 percentage points in the second quarter, indicating that the consumer may already be trading down.
It was a similar story in the oral tobacco segment, where volume and revenue both slipped by 4% and the big chewing tobacco brands, Copenhagen and Skoal, both lost share. The brand on! continued its rise though, growing by 57% and adding almost 3 percentage points of retail share. We believe this share volatility is related to macroeconomic conditions rather than any significant change in the competitive landscape, and although Altria could face headwinds to volume, mix and share in the near term, the firm's premium positioning should help it to sustain impressive operating margins above 50% in the long term.
Duke Energy Initiates Strategic Review of Commercial Renewables, Reports Second-Quarter Earnings
by Andrew Bischof, CFA, CPA | Morningstar Research Services LLC | 08-04-22
We are maintaining our $101 fair value estimate for Duke Energy after the company reported second-quarter adjusted earnings per share of $1.14 compared with $1.15 in the year-ago period. Management reaffirmed its outlook for 2022 adjusted EPS of $5.30-$5.60 and 5%-7% earnings growth through 2026, consistent with our expectations. Our stable moat trend and narrow moat ratings are unchanged.
Duke announced a strategic review of its commercial renewable energy business, one of the largest wind and solar portfolios with 5.1 gigawatts of capacity. Duke's net ownership totals 3.5 GW. The unit represents roughly 5% of total consolidated earnings and would leave Duke a fully regulated utility if the company decides to sell the unit. Management noted that the subsidiary is slower-growth than its regulated opportunities, and proceeds could be used for debt repayment and to avoid financing needs.
We don't expect any transaction to have a material impact on our fair value estimate, but we think investors will benefit as Duke directs capital toward regulated investments. Duke's announcement aligns with several peer utilities seeking to sell renewable energy portfolios. The market's appetite for renewable energy remains uncertain, given higher interest rates and broader economic uncertainty.
Earlier this year, Duke filed a proposed carbon emission reduction plan to meet North Carolina's 70% interim reduction targets as part of broader clean energy legislation that significantly improved the region's regulatory constructiveness. Duke will likely file rate cases later this year and early next year for both North Carolina subsidiaries. The investments are a key part of the company's five-year, $63 billion capital investment plan supporting our 6% earnings estimate.
Operating earnings were supported by strong electricity demand, favorable weather, and higher renewable resource in the commercial portfolio. Higher operating expenses and increased regulatory lag offset those benefits.
Edison International Maintains Steady Performance and Outlook; Still Cheapest U.S. Utility
by Travis Miller | Morningstar Research Services LLC | 07-29-22
We are reaffirming our $72 fair value estimate for Edison International after management reported $0.94 per share of core earnings in the second quarter, reaffirmed full-year earnings guidance, and maintained its 5%-7% annual earnings growth target through 2025. We are reaffirming our narrow moat and stable moat trend ratings.
Edison is the cheapest U.S. utility as of July 28, trading at a 9% discount to our fair value estimate and 15 times our 2022 earnings estimate. The utilities sector trades at a median 9% premium to fair value and 20 times P/E.
Edison continues working through several legal and regulatory uncertainties that have disguised the true earnings power of its core electric utility. We think this is one reason the stock trades at a discount to peers and our fair value estimate despite a track record of constructive regulatory outcomes, a growing dividend, and widespread support for clean energy investments. We think Edison's growth outlook and its 4.4% dividend yield offer an attractive total return.
We continue to expect Edison to average $6 billion capital investment annually for the next five years, primarily for infrastructure to support clean energy growth in California. We estimate earnings and dividend growth could accelerate to near 8% if Edison could reduce financing costs tied to regulatory and legal delays. Our outlook is in line with management's $4.40-$4.70 EPS guidance range for 2022 and $5.50-$5.90 EPS target in 2025.
Edison has resolved 89% of its estimated $7.9 billion of 2017-18 disaster liabilities. Management said it plans to seek rate recovery for those liabilities likely in late 2023. Even partial recovery of those settlement costs along with some $5 billion of other unrecovered disaster-related costs would reduce some of Edison's financing drag and accelerate earnings growth. We also await rulings related to Edison's 2022 and 2023 allowed cost of capital and its 2024 capital investment plan.
Enbridge Reports Good Q2; Partners on Woodfibre LNG and Expands U.S. LNG Efforts
by Stephen Ellis | Morningstar Research Services LLC | 07-29-22
Enbridge's second-quarter results were good, in our view. Management reiterated its expectations of a midpoint of CAD 15.3 billion in 2022 EBITDA compared with our CAD 15.4 billion forecast. We continue to expect wide oil and gas spreads to convey incremental marketing opportunities across Enbridge's footprint in the second half of the year, contributing some modest upside. With no material changes to our near-term outlook, our Canadian fair value remains unchanged, while our U.S. fair value declines to $41 per share based on updated exchange rates. Our narrow moat rating is also unchanged. Notably, about 80% of Enbridge's EBITDA has a level of protection against inflation via fixed revenue escalators or cost of service contracts.
With over CAD 3.6 billion in new projects added to the backlog in the quarter, we think the most interesting one is the investment into the Woodfibre LNG project. This project is expected to export 2.1 billion cubic feet per day of LNG and enter in service in 2027. Rather than a typical equity ownership, Enbridge expects to invest $1.5 billion in return for a preferred equity distribution based on the capital costs for the facility. This essentially converts the investment to a more stable predictable stream of income with limited to no commodity price risk. Enbridge also launched a binding open season to expand its T-South pipeline at a cost of CAD 2.5 billion-plus, which will replace volumes moving to the Pacific Northwest, allowing the Pacific volumes to feed Woodfibre.
Beyond Canadian LNG efforts, Enbridge has several others U.S. Gulf Coast projects awaiting a final investment decision. The Venice extension, the Rio Bravo pipeline, and the Valley Crossing pipeline represent another $2 billion in investments linked to the Plaquemines LNG project and connecting Haynesville to LNG efforts.
Enterprise Sees Immediate Benefits From Navitas Deal in Q2
by Stephen Ellis | Morningstar Research Services LLC | 08-04-22
Enterprise Products Partners' second-quarter results were healthy, as the full benefits of the Navitas deal flowed through to drive earnings improvements. Distributable cash flow was up 30% year over year to $2 billion. With Navitas and other earnings drivers, 2022 EBITDA is now expected to top $9 billion, an incremental $300 million-$400 million improvement. While we had initially modeled in Navitas' contributions, the difference looks to be better-than-expected fees across gathering and processing operations due to the high oil and gas price environment. After updating our model, our fair value estimate of $27.50 remains unchanged, as does our wide-moat rating.
Growth capital spending for 2022 was nudged up $100 million to $1.6 billion, while 2023 spending is now $2 billion, up from our $1.75 billion expectation. The higher spending levels are due to expansion efforts in the Permian, including two new gas processing plants. With the expansion in processing capacity due to higher expected gas demand, more takeaway capacity is also needed. Enterprise is also moving forward with an expansion of the Shin Oak natural gas liquids pipeline via looping and modifying existing pump stations to add 275,000 barrels per day of capacity. All three efforts are due in service in 2024.
While Enterprise has typically increased its distribution in the fourth quarter, it elected to boost it 5.6% this quarter to an annualized $1.90 a unit. A second increase is likely coming in the fourth quarter as part of a more robust capital return approach. Enterprise bought back $35 million in units during the quarter and plans to buy back another $300 million in units over the remainder of the year. We are pleased to see the larger unit buybacks, given Enterprise's persistent undervaluation.
Exxon's Investments, Cost Reductions Pay Off as Q2 Earnings Nearly Quadruple
by Allen Good, CFA | Morningstar Research Services LLC | 07-29-22
Exxon reported a sharp increase in earnings that exceeded market expectations as it leveraged past investments and cost reductions to fully capitalize on high commodity prices and strong refining margins. Second-quarter adjusted earnings soared to $17.6 billion from $4.7 billion the year before.
Despite the strong performance, management maintained is existing share repurchase program of $30 billion through 2023 (about 7% of market cap), which it increased from $10 billion previously during the first-quarter earnings announcement. During the quarter, it returned $7.6 billion to shareholders including $3.7 billion in dividends. Management remains circumspect about increasing the dividend and repurchases further, wanting to improve the balance sheet including a higher cash balance in the event of a down cycle so it can maintain investment, which it views as a competitive advantage. Given strong market conditions, we expect it will be able to do this while eventually increasing shareholder returns. High commodity prices and strong refining margins appear to be in place for a few years, absent an economic slowdown, given structural issues. A low-cost position combined with attractive upstream and downstream growth, should make Exxon a winner.
Our fair value estimate and narrow moat rating are unchanged, leaving shares fully valued after the post-earnings rise.
Upstream adjusted earnings increased to $11.1 billion from $3.2 billion last year due to higher commodity prices. Production increased to 3,732 mboe/d compared with 3,582 mboe/d a year ago. This stands in contrast to many peers that reported declines in production. Continued growth from high quality assets like the Permian and Guyana during the next five years set Exxon apart and should increase its ability to capitalize on high commodity prices. Permian production averaged 550 mboe/d during the quarter and remains on track to grow 25% from 2021 for the full year.
Higher Base Rates Are a Boon for Lloyds in First Half and There Is More To Come; FVE Raised
by Niklas Kammer, CFA | Morningstar Research Services LLC | 07-29-22
Narrow-moat Lloyds reported first-half underlying profit of GBP 3,746 million, versus a consensus estimate of GBP 3,401 million collected by the bank prior to the release. Income generation was strong, up 12% versus the same period a year ago. Higher base rates set by the Bank of England as well as the upswing at the long end of the yield curve have widened net interest margins at Lloyds significantly, forming the strongest tailwind since the beginning of the year. Gaining confidence from these results as well as an outlook of further rate increases over coming quarters, Lloyds again lifted its NIM guidance to above 280 basis points from above 270 basis points in the first quarter. We had anticipated a more gradual benefit at the beginning of the rate-hike cycle, but have now adjusted our NIM assumptions upward. As a result of these changes, as well as time value of money since our last model was updated, we raise our fair value estimate to GBX 77 per share from GBX 68 previously (and $3.80 from $3.70 for ADR shares). We believe Lloyds' shares are attractive at current levels.
Operating expenses increased 5% to GBP 4,249 million, due to strategic spending costs while underlying expenses remained virtually flat.
Loan losses of GBP 377 million, or 17 basis points, weighed unfavorably compared with the GBP 734 million credit the bank booked last year. That said, credit quality looks decent despite households and corporates starting to see their finances being stretched by rising inflation and higher borrowing costs.
Magellan's Q2 Results Reveal Yet More Unit Buybacks
by Stephen Ellis | Morningstar Research Services LLC | 07-28-22
Magellan's second-quarter results were solid, as the partnership held its full-year guidance of $1.09 billion in distributable cash flow unchanged. Broadly, lower oil and gas prices and higher forecast expenses in the second half of the year will offset better-than-expected crude oil earnings so far in 2022 due to higher volumes. With inflationary expectations very high, Magellan could see a potential 10%-15% increase in its indexed rates in 2023. With no major changes to its outlook, we expect to maintain our fair value estimate and wide-moat rating.
From a capital allocation perspective, Magellan's focus remains on buying back units. It added another $190 million in purchases during the quarter, bringing total purchases to $1.04 billion to date. With the purchases taking place below our fair value, we see the program as a good use of capital. With only $1.5 billion authorized under its repurchase program through 2024, we'd expect an expanded program shortly. The incremental funds from the $447 million sale of its independent terminals completed in June 2022 could easily be used to fund more buybacks in the second half of the year. Capital spending for 2022 remains at $80 million, as Magellan has not found any new attractive projects to put capital to work for the time being, reflecting its strong investment discipline.
Murky Operating Conditions Have Yet to Trip Up Procter & Gamble; Shares Aren't a Bargain
by Erin Lash, CFA | Morningstar Research Services LLC | 07-29-22
From our vantage point, Procter & Gamble's fourth-quarter results (7% organic sales growth and a 30-basis-point adjusted operating margin erosion to 18.4%) evidence it is astutely navigating the current uncertain landscape. However, the market doesn't seem to share our stance, as shares sank 5% on the print. We think this reaction was driven by the cautious tone management struck as it relates to consumer spending (in light of rising interest rates and higher prices at the grocery store and the pump) and inflation (pegged at a $2.4 billion incremental headwind, on top of $3.2 billion in fiscal 2022).
Despite the legitimacy, we posit P&G is equipped to combat these challenges. The firm's portfolio is weighted in daily use, essential categories that consumers are unlikely to abandon regardless of the economic climate. But importantly, management seems to understand it's critical to invest in innovation across price tiers and market its products. And we don't believe it will pull back on this spending, even though it has to stomach higher commodity and freight costs. This underpins our forecast for research, development, and marketing to amount to 13% of sales annually ($13 billion on average) over our 10-year explicit forecast. Further, we anticipate it will continue scouring for opportunities to extract inefficiencies, with overhead savings and marketing efficiencies aiding the operating margin by 200 basis points in the quarter.
Fiscal-year 2022 results matched our forecast, and although we'll likely edge down our fiscal 2023 marks to fall within the guidance range (flat to 2% reported sales and flat to 4% EPS growth), this shouldn't impact our $124 fair value estimate (given the offsetting time value benefit), rendering shares a touch rich at a 13% premium to our intrinsic valuation (or mid-20s the midpoint of its earnings guidance). However, we suggest investors keep this competitively advantaged name on their radar for further contraction on industry angst.
Starbucks Looks Cheap Despite Mixed Fiscal Q3 Results; Maintaining Our Fair Value Estimate
by Sean Dunlop | Morningstar Research Services LLC | 07-03-22
Wide-moat Starbucks posted mixed fiscal third-quarter results, with revenue of $8.15 billion narrowly missing our $8.2 billion forecast, while diluted EPS of $0.79 healthily outstripped our $0.63 estimate. The bulk of the difference was attributable to timing, with a planned $500 million investment in partner wages being phased in during the fourth quarter in lieu of the fiscal third quarter (where we'd penciled it in). The net effect for the full year is similar, though our full-year forecast for operating margin should tick up slightly to 13.4% from 13% due to unusually strong growth in the consumer packaged goods business, which carries 40% operating margin. We see no reason to alter our long-term forecasts of 9%, 11%, and 12% average annual growth in sales, operating profit, and EPS respectively through 2031. This reflects a marquee global brand with meaningful pricing power, increasing penetration of the cold beverages platform, and digital tools internationally, and a strong resonance with experience-driven Generation Z customers that should pay dividends for years to come. We plan to maintain our $100 fair value estimate and view shares as attractive.
During the call, management outlined the main pillars of the firm's reinvention plan, to be outlined more comprehensively at its investor day on September 13. Ultimately, we view investments in partner wages and benefits, reimagining store layouts to better accommodate the 72% of sales that now come through delivery, drive-thru and digital channels, and in customer personalization as prudent uses of capital, which should underpin more durable comparable store sales growth over the next couple of years.
Last, while we're pulling down our sales growth forecasts for fiscal 2023 by about 2%-3% amid steadily building pressure on consumer discretionary incomes, we're encouraged by traffic growth in the quarter despite three price increases over the past year, suggesting the firm hasn't priced out its core customers.
As a final note, Starbucks' Chinese business got absolutely crushed in the quarter by scattered lockdowns, with Shanghai stores being closed for roughly two thirds of the period. Comparable store sales were down 44%, almost completely due to traffic (down 43%), though the quarter's exit rate (down 25%) offers some encouragement. Management commentary suggests no reason for long-term concern, a view we share, at least from an operations perspective. Starbucks' Chinese units boast some of the best cash-on-cash returns in the industry, with unlevered payback periods typically just north of one year (returns on investment in the ballpark of 75%, disclosed during the last investor day). Indeed, we are encouraged by management continuing to invest in its brand across the region, en route to 107 net new units, or 12.2% growth from the year-ago period. That figure is particularly impressive when considering the flow-through impact of lockdowns on construction, timelines for permits, and securing restaurant equipment needed for new openings. We continue to forecast a little more than half of growth in the international segment over the next decade coming from the Chinese market, which currently comprises about 10% of consolidated revenue.
Williams Delivers Strong Q2; Raising Fair Value Estimate to $32
by Stephen Ellis | Morningstar Research Services LLC | 08-01-22
Williams delivered a strong second quarter, as volumes, fees, and marketing contributions contributed to better-than-expected results. Williams' guidance now stands at $6.25 billion, after factoring in recent strength and the Trace Midstream deal, above our earlier $6.1 billion forecast. Our revised fair value estimate after including these updates is now $32 per share, up from $31. Our narrow moat rating is unchanged. Adjusted EBITDA was up 14% year over year, due in part from core business volumes and fee strength and joint venture contributions from upstream operations at Wamsutter and Haynesville.
We consider Transco to be the best positioned natural gas pipeline in the U.S. to benefit from increased U.S. LNG exports, as virtually all U.S. LNG projects will rely on it in some form or fashion. To directly and indirectly serve that need, Williams has eight separate projects across the Northeast and Hayneville to drive earnings due in service by the end of 2023. One of the larger efforts leverages its recently acquired Trace Midstream, which is the Louisiana Energy Gateway, or LEG. This project is a 1.8 billion cubic feet per day pipeline moving gas to the Gulf Coast from Haynesville, anchored by a commitment from Trace customer Rockliff Energy. Quantum Energy Partner, the former owner of Trace, is also participating in the LEG as an equity investor and partner.
Drug Pricing Policy in the Inflation Reduction Act a Moderate But Manageable Negative to Biopharma
by Karen Andersen, CFA | Morningstar Research Services LLC | 08-01-22
The likelihood of drug-pricing policy changes in the United States changed dramatically over the course of July, and we are now assessing the impact of the various measures included in the Inflation Reduction Act of 2022 in our Big Biopharma valuation models. Assuming the bill is eligible to pass via reconciliation (the Senate parliamentarian is reviewing the bill), we think Democrats will be able to pass the Senate bill, paving the way for it to be signed into law. Overall, we don't expect major changes to our fair value estimates or moat ratings, as the changes net out to a moderate negative that we believe is manageable, likely through a combination of cost-cutting, agreements with generic firms for limited authorized generic launches (to avoid the list for negotiated drugs), and higher launch prices (to counter pressure on price increases and earlier declines due to negotiation).
From the perspective of patients, the bill reduces potential out-of-pocket costs in Medicare, making it widely popular. While government savings are highly driven by Medicare drug price negotiation and inflation caps (roughly $100 billion in savings from each measure, according to Congressional Budget Office estimates), we see three key impacts to drug firm revenue streams from the bill: shifting Medicare Part D cost-sharing to biopharma firms with more expensive drugs; penalizing biopharma firms that raise Medicare prices by more than the rate of inflation annually; and mandatory price cuts on the top-selling Medicare drugs that have extended patent protection. We had previously included potential modest U.S. drug policy changes in our Big Biopharma valuation models related to Part D redesign and inflation caps, but these didn't result in any significant fair value estimate changes.
While the House-passed Build Back Better Act stalled in the Senate earlier this year, the Senate Committee on Finance released a focused draft of potential prescription drug pricing policy changes on July 6 that largely mirrored drug policy changes included in the BBBA, albeit with slightly longer times to implementation. On July 8, the Congressional Budget Office released its assessment of the potential drug pricing legislation, estimating roughly $288 billion in savings through 2031 from prescription drug policy changes. On July 27, Sen. Joe Manchin announced his support for a larger reconciliation bill (now called the Inflation Reduction Act of 2022), which includes the prescription drug pricing policy changes released earlier in the month.
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