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We are maintaining our Neutral recommendation on Hawaiian Electric Industries Inc. (HE - Analyst Report). The company’s third quarter performance surpassed the Zacks Consensus Estimate but came in below the prior-year results.
Honolulu, Hawaii-based Hawaiian Electric Industries was founded in 1891. The company along with its subsidiaries provides electricity and banking services in Hawaii. The company mainly utilizes renewable energy sources to produce electricity. The company operates 57 branches and 119 automated teller machines. With approximately 3,654 employees, the company's market capitalization is $2.46 billion.
Hawaiian Electric is the largest provider of electricity in the state of Hawaii, supplying more than 95% of the state’s population. In contrast to its utility-only peers, the company also provides banking services to individual and commercial customers. Its banking subsidiary is one of the largest banks in Hawaii. Going forward, the major growth drivers of electricity consumption are tourism and construction, the two leading industries in Hawaii.
The tourism industry is recovering on the back of an economic recovery in the U.S. and Japan. These two countries generate the largest number of tourists to Hawaii. This is also reflected in Hawaii’s state visitor arrival, which grew by 3.8% in 2011 over 2010. State visitor expenditures also continued to grow, increasing by 15.6% in 2011 over 2010. Hotel occupancies and room rates remain higher year over year. Finally, Hawaii’s construction industry is also showing signs of recovery with a rising trend of public contracts for new commercial and industrial building permits. Hawaii’s low unemployment rate of 5.3% in November 2012, well below the national unemployment rate of 7.7%, is indicative of its economic health.
Hawaiian Electric is progressing smoothly to comply with the Hawaii Clean Energy Initiative (HCEI), which calls for generating 70% of its energy needs from renewable sources by 2030. The Hawaii Public Utilities Commission (PUC) is also supportive of the company’s focus to reduce its dependence on imported fossil fuels by substantially increasing the use of renewable energy. The company plans to spend approximately $3 billion over the five-year period 2012 through 2016 for capital expansion programs with a distinct focus on renewable energy projects. Of the projected $3 billion of capital expenditures, approximately 39% are targeted for environmental compliance, infrastructure investments for fuel and to integrate renewable sources into the system; 38% are earmarked for transmission and distribution projects; 13% for generation projects; and 10% for maintenance.
Along with long-term expected earnings growth of 6.4%, this Zacks Rank #2 (Buy) stock also offers a solid dividend yield of 4.9% (Zacks Industry Average 3.5%). The company has been paying stable and consistent dividends since 1901, which adds to the attractiveness of its shares. Going forward, we believe the company is well positioned to continue to deliver attractive earnings growth with reduced risk and volatility cumulating in an above-average dividend yield.
On the other hand, Hawaiian Electric generates a major portion of its consolidated revenue by supplying electricity in Hawaii. Accordingly, the company’s earnings prospects are highly correlated with the strength of the underlying Hawaiian economy, which in turn depends primarily on Japanese tourism.
Hawaiian Electric’s performance will be affected if there is any adverse regulatory decision. It would be difficult for the company to sustain its profitability, resulting in capital expenditure reductions. Also the company’s position as a bond-proxy makes it vulnerable to swings in market interest rates. All these may hamper Hawaiian Electric’s borrowing cost from the market, which in turn would constrain future rate base growth of the utility.
Finally, the actual return on equity (ROE) of the company’s electric utilities remains a tad below the approved rate of return. The company is gradually narrowing the gap between its actual and allowed ROEs by implementing sales decoupling, revenue adjustment mechanisms and general rate increases. However the company still has to go a considerable way before it can match the approved rate. Also, Hawaiian Electric’s focus on adding new assets has resulted in rising operations and maintenance overhead. The company anticipates operations and maintenance overhead to increase by 6% in fiscal 2012.
Hence, we see the stock as having limited upside potential. We maintain our Neutral rating on the stock and expect it to perform in line with the broader market. This is in line with its peers CMS Energy Corporation (CMS - Analyst Report) and OGE Energy Corporation (OGE - Analyst Report).