Dividend Investing: ALLETE Inc (ALE)

Investing in stocks that pay high dividends is an effective way for the conservative investor whose concern is mainly with the preservation of capital. When investing for a high dividend yield, the most important consideration for the investor is the sustainability of such dividends. Hence research into the underlying dividend payer is crucial.

I should make it clear that I’m not recommending any of the stocks I write about. Any investor who is contemplating investing for a high dividend should use these articles a base from which to do further research and in depth analysis.

Previously I highlighted telecom company CenturyTel (CTL) in this article, and have also covered Duke Energy (DUK) in this piece. In addition I did a piece on lesser-known Mercury General (MCY), which can be found here. In the energy sector I wrote an article on TC Pipelines, found here.

ALLETE (ALE) is an energy company, operating in two segments: Regulated Operations and Investments. Regulated Operations includes its regulated utilities, Minnesota Power and Superior Water, Light and Power Company, as well as its investment in American Transmission Company LLC, a Wisconsin-based regulated utility that owns and maintains electric transmission assets in parts of Wisconsin, Michigan, Minnesota and Illinois. The Investments segment primarily comprises BNI Coal, its coal mining operations in North Dakota, and ALLETE Properties, LLC, its Florida real estate investment.

Despite a 32% decrease in earnings per share for the 2009 fiscal year, due to lower revenue and a higher number of shares in issue, the company trades below the industry average in all valuation metrics. At the current stock price of $35 the company trades on a PE ratio of 18.4 times, which is below the industry average of 19.5 times. The high PE ratios are associated mainly with lower earnings in 2009 which are expected to increase back to normalized levels for the 2010 year. The quick ratio at 1.3 times is high for a regulated power and water business and demonstrates the financial strength of the company. Price to sales at 1.6 and price to cash flow under ten times is indicative of the relative value available at which to acquire predictable future cash flows.

Despite the decline in earnings the company actually increased it’s dividend for 2009 by 4% to $1.76 per share. This brings the payout ratio over the past three years to about 68% (meaning the company pays out about 68% of earnings in the form of dividends). ALLETE is committed to providing an attractive, secure dividend to its shareholders while, at the same time, funding its growth strategy. The Company’s long-term objective is to maintain a dividend payout ratio similar to our peers and provide for future dividend increases. Additionally, the company’s return on equity of 6.95% coupled with the high-payout ratio would indicate that continued high dividends can be expected. This is because the company has few projects that provide a high rate of return on cash generated and as such pay out excess cash to shareholders.

The company could afford to pay out such a high dividend because it generated $137 million in cash from operations last year. This is the second highest amount the company has ever generated and proves the strength and stability of the underlying cash flows associated with the regulated energy business, regardless of the lower accounting earnings figure reported.

Interestingly the main key risk the company lists in its 10-K filing related to its business is the “green” movement and the risk of environmental change. Investors would need to be conscious of this if taking a longer-term outlook on the company. “The scientific community generally accepts that emissions of green house gases are linked to global climate change. Climate change creates physical and financial risk. These physical risks could include, but are not limited to, increased or decreased precipitation and water levels in lakes and rivers; increased temperatures; and the intensity and frequency of extreme weather events. These all have the potential to affect the Company’s business and operations. Proposals for voluntary initiatives and mandatory controls to reduce GHGs such as carbon dioxide, a by-product of burning fossil fuels, are being discussed within Minnesota, among a group of Midwestern states that includes Minnesota, in the United States Congress and worldwide. We currently use coal as the primary fuel in 95% of the energy produced by our generating facilities”.

They add, “Minnesota Power is subject to numerous environmental laws and regulations which cap emissions and could require us to purchase environmental emissions allowances to be in compliance. The laws and regulations expose us to emission allowance price fluctuations which could increase our cost of operations.”

It’s my opinion that such change is unlikely to result in serious adverse consequences at least over the medium term for investors, and as such should be a factor but not dissuasion for the dividend seeking investor.