Beware Of Risks In Utilities - PG&E Suspends Its Dividend

I was shocked to read the news yesterday about PG&E (ticker PCG) suspending its dividend. It was quite unbelievable since the company recently (as of May of this year) increased its dividend by 8.2% with a dividend paying history of over 10 years.

What makes a company go from raising a dividend to completely stop paying it, in just a few months?



Let's do a little postmortem of PCG and its dividend and see whether there were any signs an investor could have seen to protect themselves from the impending dividend suspension.

We will start by checking typical dividend related metrics to see if there is anything that stands out as a potential red flag for the stock and its dividend.

Credit Rating

PCG has a S&P credit rating of A- which means the credit agency sees the company as a low credit risk. To give you a little prespective, a credit rating of BBB- is the lowest investment quality credit rating. Therefore, PCG credit rating of A- is way up on the credit quality scale, and considered a very strong company when it comes to credit worthiness.

The A- credit rating also puts PCG in the same ranks as the bigger utilities SO and DUK which also have same credit rating.

Dividend Coverage

PCG has maintained an earnings dividend payout ratio in low to mid 50% for the past three years, and in the last 10 years, its payout ratio has never exceeded over 67%.

That's a pretty conservative payout ratio and beats some of the other well known utilities like SO, DUK, and D whose payout ratios are well into the 70s%.

Therefore, PCG looks better than some of the other blue chip utilities when it comes to dividend payout ratio.

Debt Levels

PCG has a Dept/Cap ratio of only 44%. This is quite low when compared to other utilities such as SO and DUK who have Dept/Cap ratios of 57% and 51%, respectively.

Dividend History

PCG has a broken dividend history as indicated by the green line in the chart below.

A Broken Dividend History
In 2001, PCG stopped paying dividend and didn't reinstate it till 2005.

So what caused it to stop paying dividend in 2001?

Back in the 2001, it was the deregulation of utilities that got them in trouble. Utilities started to invest money everywhere. Some utilities were even investing money in car lots and buying concrete companies. Enron created a future electricity futures market that almost destroyed the industry.

In 2001, PCG found itself in trouble and filed for bankruptcy. Shareholders were wiped out, but the company continued to operate. It wasn't till 2005, when the utility emerged from bankruptcy and reinstated its dividend.

Since then the company got its act together and also deregulation was not an issue anymore. This allowed company to continue to pay dividends reliably for another 12 years and even increased its dividends a few times.

Dividend Growth

Over the past 12 years, the dividend growth has not been spectacular for PCG.

It has increased dividends only 7 times in the past 12 years with an average dividend growth rate of 4.2%. So, definitely not a consistent dividend growth story, but still a decent dividend growth over 10 years.

Dividend Safety Score

I checked one of the popular and well respected dividend rating websites Simply Safe Dividends (SSD) to see what dividend safety score it has on the PCG.
Source: Simply Safe Dividends (www.simplysafedividends.com)

Not surprisingly, SSD has listed a dividend safety score of 90 for PCG. Which is translated to be a 'Very Safe' dividend.

My guess is that the SSD website uses fundamentals or quantitative analysis to determine the dividend safety of a given stock and since PCG didn't show any signs of fundamental deterioration, the SSD tool was not able to see any risks with PCG's dividend.

I would say, this would be the case with any tool or analysis that simply looks at quantitative numbers to determine dividend safety.

It Was A Black Swan Event

Yup, that was it. It was a Black Swan Event of California wildfires that got PCG in trouble this time.

Under California law, a utility company is responsible for damages if its equipment was in anyway involved in causing the damage or in this case starting the fire.

PCG doesn't know for sure whether it was their equipment that started the fires, but to be prudent they decided to stop paying dividends and have the cash in hand to pay for damages in case they end up being liable for the fires.

There wasn't a whole lot of warning for the investor except for when the fire started. The PCG stock has been in a nose dive since the fire started few weeks ago. So maybe that was the warning that PCG dividend could be at risk.

How To Protect Against A Utility Black Swan Event

Diversify By Geography/State

Don't put all your investment in utility companies in one state. Instead, look to diversify across many utility companies across different states and geographies.

No one can predict natural disasters, having a geographically diversified utility portfolio can help mitigate some of the Black Swan Event risk.

Know the Regulatory Environment

Utilities are governed by a regulatory body in the state they do business in. A regulatory body is responsible for approving rate hikes and future investment projects for a utility. Without the approval of a regulatory body, the utility cannot function.

It is, therefore, extremely important that the regulatory agency is friendly to the utility company and does not pose crippling regulatory rules to impede needed rate hikes or future projects in addition to limiting liabilities from future disasters.

In some cases, such as in the case of SCG (A utility company in SC), a regulatory agency can force the utility to pay back or claw back past rate hikes because a certain project didn't get completed. SCG stock has taken a major hit and down over 40% this year.

Understand The Management's Commitment To Dividend

History can tell you a lot about a company's management and its commitment to dividend and shareholders. Knowing the management's commitment to its shareholders is part of qualitative analysis.

In the case of PCG, history made it quite clear that the management has failed its shareholders in the past by suspending dividends in the early 2000. Whatever the circumstances may be, the dividend was suspended in the past and therefore, there is already a precedence for it to happen again.

So, in the case of PCG, history is repeating itself. A good management would do anything in their power to prevent dividends from being cut or worse suspended. They would have built-in ample cash cushion to meet any unforeseen natural disaster or financial headwinds.

Now, PCG has two dividend suspensions in its history. That should be a big warning for the future investors in the stock.

Size Matters

When it comes to utility companies, size matters. The larger the utility company, the better the chance it has to survive a major disaster or a regulatory dire.

Both SO and SCG faced the similar regulatory dire after their failed nuclear power plant projects this year. However, SO weathered the storm much better than SCG, mainly due to its shear size and influence. Whereas SCG finds itself in big trouble and its dividend is in danger of cut or suspension similar to PCG's fate.

Conclusion

As a dividend investor, keep your eyes and ears open for any news or event that could have a material impact on the stock or its dividend. Don't expect a utility company's dividend to be any safer than other companies. Diversify across geographic regions to disperse the risks from major disasters.

Thanks for reading and before I forget: Happy Holidays to all my readers :)


Disclosure: I do not own or ever have owned PCG. I do own SO, DUK, and D as my long-term utility holdings.

Disclaimer: Author of this article is not a licensed/registered financial or investment adviser and does not provide investment advice. Any mention of stock names/tickers in this article or website is not a recommendation to buy or sell. Please do your own due diligence before buying any stocks. This article is for informational and entertainment purposes only. Full disclaimer can be read here: Full Disclaimer

Comments

  1. Very unfortunate for the investors of this company. Kind of reminds me of BP during the oil spill, on a different scale of course. Although BP was able to go on for awhile before they cut the dividend if memory serves.

    And you are right about the importance of diversification. People get tired of using that word but events like this are why it is mandatory.

    I wasn't familiar with the SSD site. I learned a couple things today! Thanks for the insight and analytical post.

    ReplyDelete
    Replies
    1. Hi DS,

      Yes, very unfortunate for those investors. BP dividend cut was awful too, even more so as BP is considered a widow and orphan's stock and people count on its dividend to be always there.

      Regarding SSD, I'm using their free trial membership as I was curious about their dividend rating system. The free trial is good for 14-days, after that it's $399/year. It's a bit expensive for me and I can do dividend quantitative analysis myself, but people do find them useful and they are quite popular on SeekingAlpha.

      Thanks for the comment and stopping by DS.

      Delete
  2. I think the utility sector has underperformed the broad stock market index this year. I think it's generally just because the utility sector moves more slowly, so when the stock market goes up 20% in a year, the utility sector will go up <20%.

    ReplyDelete
  3. Crazy to see something so drastic happen in such a short amount of time. Especially coming from a sector that most people consider relatively "safe". Have both DUK and SO on my watch list. As you mentioned, smart to diversify over a few utilities. Already have a decently big position with D so feel like I should spread it out a little bit more in that sector. Thanks for the great read.

    ReplyDelete
    Replies
    1. Hi Daze,

      Yes that's the thing about utilities, they are supposed to be defensive sector, but the term 'defensive' only seems to apply to the beta or how volatile there stock price is compared to overall market.

      Utilities normally don't have much free cash flow cushion since they are highly capital intensive, therefore it doesn't take much for a utility to go from well performing to almost going bankrupt.

      PCG was hit by a natural disaster, there wasn't much warning for the utility or the shareholders as the stock nose dived. I hope they can survive without going bankrupt as that would be the worst case for the shareholders.

      Both D and SO are my two largest utility positions, I watch them closely though I've confidence in their management and their shear size to weather any storm, but still you never now, sometimes it is the management that fails the company and the shareholders.

      Always a good idea to spread out and diversify and not be too over weight in any one position. At least that's what I like to do.

      Take care

      Delete
  4. Hi Mr. ATM, Happy holidays. Sorry I'm a little last responding to your post. I have been out of town the last few days celebrating Christmas with my wife's family. I decided to go mostly offline while I was away. Thanks for the recap on PG&E. I have never owned the company and have had pretty good fortune with the other utilities I have owned. You mention several of them. It goes to show that even the best researched company can still undergo an unexpected event that negatively impacts shareholders. Investing in stocks has risks, no matter what one's research shows. It means that diversification among companies and industries remains important to guard against the completely unexpected. Tom

    ReplyDelete
    Replies
    1. Hi Tom,

      Happy Holidays to you too. I figured you were taking a break from blogging and enjoying Christmas with family. That's what holidays are all about :)

      I also took a break from investing/blogging and started to learn to play a music keyboard. Just taking a few music lessons online, will see how far I get with it. That would be one of my new year resolutions to learn to play music on a keyboard/piano.

      You are absolutely right about investing, no amount of research can 100% remove the risk, and risk is part of the game but diversification can help manage that risk.

      I was just watching Nightly Business News (I think it was from yesterday) and they were talking about some retirees who lost all their savings when their broker invested them in bond funds which were laden with high risk Puerto Rico bonds, and lost almost all their value. A reminder for people who invest in mutual/bond funds to know what they are invested in and whether the funds are diversified.

      Take care Tom and enjoy rest of your holidays :)

      Delete
    2. Good luck on the music front Mr. ATM. I have often thought the same about pursuing music in this phase of life. I played trombone in grade school and high school and tried the guitar in my 20's. Like anything worthwhile it takes a lot of work. I think teaching and now blogging have helped me fulfill my creative needs so have put it on the back burner. Have fun. Tom

      Delete
    3. Thanks Tom and yes it does take a lot of work and time to learn to play music. Like you said, anything worthwhile takes lot of work.

      I'm trying to learn it the right way by first mastering the basics, the fundamentals, before trying to be creative with it. It's like learning to read or write a language, got'a know your alphabets. My hope is that one day I'll be able to play music on the keyboard freely and express my creativity.

      With your experience in playing trombone and guitar, I might ping you from time to time for some encouragement or advice.

      Always a pleasure chatting with you Tom.

      Take care

      Delete
  5. Wow. Thanks for the write up. I don't own PCG but I was considering getting SO at one point. Additionally, when I consider companies, I also look at SSD to see what the dividend safety score is. It just goes to show you that diversification is important. Not just diversification of stocks you invest in, but of tools you use to do your research. You make excellent points of things to consider before investing in utilities. So, thank you.

    ReplyDelete
    Replies
    1. Thanks DP for reading and commenting and you make a very good point about the tools.

      Delete
  6. Very Good thoughts, I agree to your overall article and summing up nice facts for utility companies.

    Happy Investing.
    TDK.

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  7. If they fixed that I would like it much more.

    ReplyDelete

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