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Bottom of the Barrel: Tropical Treat With Hawaiian Electric





I'm always looking for something exotic to add to the Bottom of the Barrel Portfolio, but in today's market, I'm leery of anything I don't completely understand.

So, I'm excited to announce that I found what I was looking for: the understandable, exotic Hawaiian Electric (HE). The company that powers the 50th state is a traditional utility with a twist: It also owns the third-largest bank on the islands. Its diverse, yet focused, business strategy and history of paying dividends continuously since 1901 -- some 58 years before Hawaii actually became a state -- make Hawaiian Electric an inviting investment oasis amid a growing number of troubled power companies.

Powering the Islands

Hawaiian Electric operates 15 power plants on five of Hawaii's islands and provides power to 95% of the state's 1.2 million residents. Unlike the maze of new businesses formed by many mainland electric utilities, which have exponentially increased their risk, Hawaiian Electric continues to operate as it always has, serving its customer base from a regulated rate of return by the Hawaii Public Utilities Commission.


At a Glance
Hawaiian Electric (HE:NYSE)
Current Price $39.85
52-week Range $47.80 - $34.55
Price-to-Earnings Ratio* 12.2
Market Cap $1.4 billion
Avg. Daily Volume 145,818
Inst. Ownership 26%
Dividend Yield 6.22%
Beta 0.00
Company Web site www.hei.com
*Based on 2002 Estimates Source: Market Guide, FirstCall, Company Reports

In fact, the company's brief foray into the international power business ended last year when it sold a small power plant in Guam to Mirant (MIR) and discontinued other developments in Asia.

Although a regulated rate of return limits the upside to growth, it also provides a level of comfort for investors looking for stability and certainty. Make no mistake, Hawaiian Electric won't grow earnings by 10% a year anytime soon, but it is likely to provide a mid-single-digit rate of return that, combined with the current dividend, makes a nice, stable addition to a risk-averse portfolio.

Banking on Growth

The twist to Hawaiian Electric's story is its ownership of American Savings Bank, which has more than $6 billion in assets. The bank was able to grow net income by nearly 20% in 2001 while reducing the cost of funds and increasing net interest rate margins. In the first half of 2002, the bank saw net income rise more than 15%, excluding gains associated with the elimination of goodwill amortization.

In addition, while the Hawaiian economy heavily depends on travel and tourism, the bank has been able to keep loan delinquencies in check. Delinquencies remained flat in the first quarter of 2002 when compared to 2001 levels.


Powering Aloha
Hawaiian Electric surges ahead
Year Revenue (in millions) Earnings Per Share
2000 $1,719.0 $2.54
2001 1,727.3 3.19
2002* 1,602.0 3.27
2003* 1,698.0 3.49
*Estimates
Source: FirstCall, ValueLine, Company Reports, TSC Research

So what's the biggest challenge that American Savings faces to continue its pace of growth? It needs to successfully evolve from a traditional savings bank, with a heavy focus on consumer deposits and mortgage lending, to a full-service community bank that offers a range of both consumer and commercial banking products. The company's 71 branch offices across the islands are well positioned to attract new commercial lending business as the Hawaiian economy recovers.

Powering Ahead

Hawaiian Electric is a relatively simple story to understand. The utility provides stability, regulated cash flow and a compelling dividend. The bank provides the potential for growth as long as it maintains a conservative lending profile and strong balance sheet. Under current management, both are likely.

The risk to Hawaiian Electric investors is opportunity cost. Because the company operates in relative isolation with little chance of trying to grow beyond its borders, the upside is both easily defined and limited. I assume 4% to 6% annual earnings growth plus the dividend. Historically, buying Hawaiian Electric with a dividend above 6.2% is a good investment. An entry price in the high-$30s seems reasonable, given current fundamentals. Even after a 1.5 million share offering last year, the stock is still thinly traded for an electric utility, and pricing can be choppy.

The other risk is the Hawaiian economy. Both the utility and bank seem to have weathered the current downturn well, but additional shocks to travel and tourism could decrease power demand and significantly affect lending demand and quality.

Still, in an investment environment where investors pay a premium for stability and certainty, Hawaiian Electric fits the bill. Although it's slightly above the optimal entry point for individual investors, I like the business and the dividend. I give Hawaiian Electric two barrels and add it to the Bottom of the Barrel income portfolio. For an explanation of our barrel rating system, see our description.

Barrelology

After last week's selloff in many of the Barrel names, the stocks reacted positively as the market rallied.


What a Difference a Week Can Make
A rising market lifts most stocks
Current Rating Company/Ticker Date of Mention Current Price Mention Price* % Change From Mention % Change Last Week
Above Average Outlook
Superior (SUP:NYSE) July 10, 2002 $45.45 $43.87 3.60% 12.61%
Roadway (ROAD:Nadsaq) June 19, 2002 31.26 34.03 -8.14 0.06
Fidelity National (LION:Nasdaq) May 8, 2002 9.20 10.58 -13.04 -0.22
UCBH Holdings (UCBH:Nasdaq) March 27,2002 40.22 35.65 12.82 10.59
Cost Plus World Markets (CPWM:Nasdaq) March 6, 2002 26.40 25.83 2.21 18.60
NetBank (NTBK:Nasdaq) Feb. 6, 2002 9.40 13.45 -30.11 -4.76
Coastal Bancorp (CBSA:Nasdaq) Dec. 12, 2001 28.61 27.84 2.77 0.74
FPIC Insurance (FPIC:Nasdaq) Nov. 14, 2001 11.10 12.83 -13.48 -6.09
Average Outlook
Innotrac (INOC:Nasdaq) June 12, 2002 $5.25 $4.79 9.60% 19.86%
Champps Entertainment (CMPP:Nasdaq) May 29, 2002 10.60 13.01 -18.52 2.51
Trico Marine (TMAR:Nasdaq) May 1, 2002 4.56 8.25 -44.73 -6.75
Rare Hospitality Intl. (RARE:Nasdaq) Feb. 20, 2002 26.68 25.72 3.73 22.95
SurModics (SRDX:Nasdaq) Dec. 19, 2001 25.10 34.60 -27.46 21.61
VitalWorks (VWKS:Nasdaq) Nov. 21, 2001 7.42 4.30 72.56 17.03
Coinstar (CSTR:Nasdaq) Nov. 7, 2001 28.75 19.96 44.04 7.56
Witness Systems (WITS:Nasdaq) Oct. 31, 2001 5.03 8.06 -37.59 3.93
Hibbett Sports (HIBB:Nasdaq)** Oct. 24, 2001 19.51 20.04 -2.64 11.68
Quixote (QUIX:Nasdaq) Oct. 3, 2001 16.43 21.44 -23.37 10.57
Below Average Outlook
Wilsons Leather (WLSN:Nasdaq) May 22, 2002 $8.70 $14.96 -41.84% 0.00%
Arch Chemicals (ARJ:NYSE) April 24, 2002 20.75 22.52 -7.86 5.76
Hines Horticulture (HORT:Nasdaq) April 17, 2001 3.68 4.75 -22.53 20.66
Actrade (ACRT:Nasdaq) Jan. 30, 2002 2.50 20.65 -87.89 21.36
Endocare (ENDO:Nasdaq) Jan. 23, 2002 12.00 18.21 -34.10 6.38
Quanta Systems (PWR:NYSE) Jan. 9, 2002 2.25 16.05 -85.98 -19.06
Goody's Family Clothing (GDYS:Nasdaq) Nov. 28, 2001 4.62 4.50 2.67 33.91
Bridgford Foods (BRID:Nasdaq) Oct. 10, 2001 12.35 13.18 -6.30 8.81
Bottom of the Barrel Income Portfolio
JDN Realty (JDN:NYSE) July 17, 2002 $12.04 $11.57 4.06% 8.08%
UGI Corp (UGI:NYSE) June 26, 2002 30.41 31.30 -2.84 9.59
Acadia Realty (AKR:NYSE) June 5, 2002 7.70 7.03 9.53 10.00
Capital Automotive REIT (CARS:Nasdaq) April 3, 2002 23.33 22.95 1.66 9.38
Laclede Group (LG:NYSE) March 20, 2002 22.74 23.64 -3.81 14.04
Alexandria Real Estate (ARE:NYSE) Feb. 13, 2002 43.20 40.25 7.33 7.12
Empire District Electric (EDE:NYSE) Jan. 16, 2002 17.75 21.23 -16.39 3.62
Integra Bancorp (IBNK:Nasdaq) Jan. 2, 2002 22.05 20.75 6.27 -0.32
Met-Pro (MPR:NYSE) Oct. 17, 2001 13.00 11.16 16.49 0.08
Bottom of the Barrel Special Situation Portfolio
Luby's (LUB:NYSE) Feb. 27, 2002 $6.15 $6.22 -1.13% 6.03%
*Average price on date of mention.
**Prices adjusted for 3:2 split on Feb. 20, 2002
Source: Thomson Financial/First Call, TSC Research

A couple of key pieces of news: Rare Hospitality (RARE) announced better-than-expected earnings, and the stock jumped nearly 23%. I like the continued improvement in operating efficiencies as well as the business model.

Witness Systems (WITS) reported earnings of 2 cents per share for the second quarter, in line with expectations. The stock gained nearly 10% Tuesday. In the second quarter, the company added a host of new clients to its growing list of major companies that are using its customer service monitoring software, including BMW Financial Services, Eli Lilly and GE Consumer Finance Japan. A better feel for business going forward would make me more comfortable with the stock, but I like its market-leading position and growing client base.

I'll take a complete look at second-quarter earnings for the Barrel portfolio next week.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, Edmonds' firm was long Mirant, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds.

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