Entergy Shareholders Could Get a Boost

 | Nov 12, 2012 | 5:06 PM EST  | Comments
  • Comment
  • Print Print
  • Print
Stock quotes in this article:

etr

,

exc

,

itc

,

pom

,

duk

The more things change at Entergy (ETR), the more they remain the same. At least for current shareholders, there is a possibility that they will receive two separate dividend streams.

Entergy is planning a spinoff and merger of its vast transmission line assets with ITC Holdings (ITC). Transmission lines are the backbone of a utility system, and they do not include local distribution systems. Because transmission lines are engaged in interstate commerce, they are regulated not by the state but by the U.S. Federal Energy Regulatory Commission (FERC).

Local distribution systems are what many people understand as an electric utility. Distribution systems rarely traverse state lines, they are not regulated by FERC, and they are usually regulated by state utility commissions.

The deal contemplated by Entergy and ITC is limited to FERC-regulated transmission lines. Entergy and ITC plan a Reverse Morris Trust, which is a tax-free structure that allows for a division or portion of a company to be spun out and merged into another company in a stock-for-stock exchange.

Post-merger, Entergy shareholders would own 50.1% of the combined company. Because current shareholders will become shareholders of the merged company, they will also receive ITC dividends. So current shareholders may not see an overall decrease in dividend payments.

However, management warns that investors who buy Entergy after the spinoff would receive only one set of dividends. It makes sense. A lot of Entergy's assets are moving to a separate entity.

Nevertheless, in the last conference call, Entergy's executives were less than clear about their dividend's future. According to Entergy Chief Financial Officer and Executive Vice President Leo Denault, Entergy will make the dividend decision at the time it closes on the ITC transaction.

"And we've always said that we'll make the decision and we'll size it at the time of the transaction, when it closes. When we look at it where we -- when we were talking about sizing that up back in December when we announced the transaction, we mentioned that, as those things looked at the time, it was possible that the $3.32 could stay in place and we could grow into that dividend. So we're not really saying anything different right now, other than we'll make that call at the time based on what happens during the 18-month-plus time frame between when we announced it and when we actually close. But it'll be not what happens between now and 2014, but what happens in 2014 and beyond that'll drive that decision on the dividend."

But management's forecast for 2014 and beyond does not support maintaining the dividend at current levels. Like Exelon (EXC), Entergy operates a large nuclear power fleet. And like Exelon's nuclear fleet, Entergy's appears to be struggling with declining wholesale power prices and related margins. On the basis of Energy's forecasts, it is unlikely that Energy can "grow into its dividend" if current payout ratios are to be maintained.

The payout ratio is an important metric for many investors. It is defined as the company's dividends per share divided by its earnings per share. Ratios exceeding 1 suggest trouble, because the company is paying out more to shareholders than it earns from its business lines.

Some utilities are saddled with high payout ratios. Pepco Holdings (POM) and Duke Energy (DUK) sustain unhealthy payout ratios because they allow depreciation and other costs to exceed their reinvestment, or they starve their operations of working capital.

Entergy's priority is to keep the payout ratio at reasonable levels and maintain the company at investment grade. It appears that Entergy's management will be forced to resize its dividends after the merger.

But present shareholders should not be concerned. If all approvals are secured, current shareholders will become owners of two dividend-paying companies. Part of their investment will include their original interest in Energy, and the other part will include the new transmission line company with ITC. Existing shareholders should end up with two sources of dividends: Dividends from Entergy and even more dividends from ITC.

If you listened to the conference call, you might have heard management argue that the combined dividend should at least equal current dividends. But over time, the combined dividends could grow, particularly if the wholesale power markets improve.

Disregard commentary that overreacts to management's discussions over Entergy's dividends. The spinoff and merger will benefit Entergy's current shareholders. Future shareholders will have different metrics and different decisions. But for now, Entergy's approach regarding its transmission systems seems to be in shareholders' best interest.

Columnist Conversations

Markets seem to be taking breaking news going across wire that two Ukrainian militaryfighter jets have been sh...
Lang:
As I was away on vacation last week I still kept one eye on the markets and with my technological devices at h...
We are currently testing the key resistance decision in ICE. Do not consider an entry without a trigger!! ...
Is this the biotech revolution or the biotech bust? View Small Cap Biotechs Like Never Before: Transparency is...

BEST IDEAS

REAL MONEY'S BEST IDEAS

Columnist Tweets

BROKERAGE PARTNERS

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data provided by Interactive Data. Company fundamental data provided by Morningstar. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by Interactive Data Managed Solutions.


TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

IDC calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.