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
. 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.
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
( 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.
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.
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.
After last week's selloff in many of the Barrel names, the stocks reacted positively as the market rallied.
A couple of key pieces of news:
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.
( 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
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