TECO Energy Inc. (NYSE: TE) over the past year has been one of the best performing stocks in my Strategic Advantage StrataGem portfolio.
The stock has jumped 7.75% in just the past month, is up more than 30% in the past year, and it pays a generous 4.7% annual dividend.
So here's what it is all about.
TECO, which is based in Tampa, provides electricity to 667,000 customers and natural gas to 330,000 individuals in west central Florida. It also operates a coal mining operation in Kentucky and a small utility in Guatemala.
Since 2003, TECO - formerly called Tampa Electric - has reshaped itself into a regulated utility from a diversified energy company. It sold $4 billion of assets and reinvested the proceeds in regulated utility projects with attractive returns. The regulated units, Tampa Electric and Peoples Gas, now generate 90% of TECO's profits. TECO's $3.52 billion market cap and $3.40 billion in annual sales make the company one of the smaller utilities in the United States.
Investors have flocked to TECO as a utility in a relatively stable part of the Southeast that provides steady profits at a time of uncertainty. Expect the uptrend to continue as bond yields hit decade lows and income-oriented investors seek out greater returns.
Florida historically has been one of the most stable and business-friendly regulatory environments for utilities. Regulators understand that utilities must deal with a dense population and annual hurricanes. And to compensate for these issues, TECO is granted one of the highest returns on equity of any utility: 12.25%.
To achieve this high return, TECO must persuade regulators that higher rates are necessary to pay for infrastructure investment. This is difficult, because Florida's unemployment rate is one percentage point above the natural average and energy demand in the area remains weak. Chief financial officer John Ramil is optimistic, since TECO has experienced two consecutive quarters of growth after 18 months of stagnation.
One exciting feature about TECO's energy portfolio is the Polk Power Station. It is a next generation power plant that turns coal into a clean-burning gas, reducing greenhouse gas emissions. The plant also is designed to reuse exhaust heat to operate more efficiently.
TECO operates 34 Kentucky coal mines that help stabilize input costs. Nearly half of TECO's electricity is generated by coal, so commodity price swings have limited adverse effects.
TECO also has Latin American exposure, as its Guatemalan subsidiary owns two power plants and a minority interest in an electric distribution system. This division contributes roughly $40 million to earnings annually.
As the market seesaws through earning season, it's nice to recognize that StrataGem is picking out stocks that will rise with the least downside volatility. TECO fits this bill with a very consistent dividend record. Before 2003, the company had raised its dividend for 43 consecutive years and never missed a payment. TECO recently raised its annual dividend by 2.5% for 2010.
Executive compensation is tied to return on equity and cash flow, which helps align chief executive Sherril Hudson's incentives with investors' interests. Hudson lives in Miami, which is 280 miles from TECO's Tampa headquarters. So when he racked up $50,000 in commuting costs before the corporate jet was sold in 2009, the board of directors made him pay up. The board also did not reward executives when the company and stock underperformed. To the contrary, it froze 2009 salaries at 2008 levels.
In summary, TECO has become an attractive investment, since moving back to its core competencies. The company generates strong cash flow, pays a solid dividend, and has one of the highest returns on equity of any regulated utility.
Analysts expect TECO to earn $1.41 a share in 2011, pricing the stock at 11.7-times forward earnings. Historically, the stock has been valued at 13-times earnings. Using my model's $1.50 earnings estimate, we are looking at a share price target of $19.50.
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