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A Buy on Allegheny Energy
Going forward, Allegheny Energy, Inc.’s (AYE - Analyst Report) positive investment factors include growing earnings, favorable market prices, higher generation rates, increased retail sales long-term supply agreements and a reinstated dividend. These positive factors are partially offset by higher fuel expenses on account of higher coal prices as well as higher operation and maintenance expenses.
We expect that the company’s regulated delivery utility business will provide steady earnings growth, while the generation business will provide an additional boost to earnings. However, higher environmental-related capital expenditures remain a concern. Reinstatement of the company’s quarterly dividend is certainly a positive, although it currently yields a relatively unattractive 1.12% -- lower than the electric power utility industry average yield.
However, we believe the sustainability of the dividend is supported by higher operating cash flows as well as reasonable projected earnings payout ratios. As of the date of this report, AYE trades at 19.2x and 13.8x, respectively, our 2008 and 2009 earnings per share estimates, or at a moderate premium to the electric power utility industry average multiple and comparable diversified energy utilities. Likewise, AYE trades at the upper-end of the ranges of its industry peers based upon relative multiples of sales and book value, yet roughly in-line with respect to multiples of cash flow.
Nevertheless, given the successful status of the turnaround and long-term projected EPS growth rates among the highest of all utilities and many times greater than growth expectations for the broad industry, we maintain a Buy recommendation on AYE. We have set a six-month target price of $55, representing 21.6x and 15.5x, respectively, our 2008 and 2009 EPS estimates. Price appreciation to our near-term valuation target, coupled with a 1.12% annual dividend yield which we consider sustainable and secure based upon projected dividend payout ratios of 24% and 17% of our projected 2008 and 2009 EPS estimates represents annualized total return potential of 27.7%.
Read the full analyst report on AYE.
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