Description

The cheapest utility in North America on year 2001 earnings.

Green Mountain Power supplies electricity to north-central, southern and southeastern Vermont. The company's customer serves approximately 84,000 total customers. Their present fuel mix is roughly 43% hydro,30% nuclear, and the balance a mixture of coal, oil and natural gas.

I am recommending Green Mountain Power as an excellent short term and long term buy for growth oriented utility investors. This was a fallen angel... which has just experienced a significant earnings catalyst.

Prior to 1997 Green Mountain Power was widely considered to be the one of the most efficiently run utilities in the United States. As the company had a small customer base, GMP chose to purchase most of their electrical output from outside suppliers. 70% of their power is purchased. This left them with a smaller percentage of equity tied up in power plants. Since there was little in the way of significant investment in plant, most of the earnings were paid out to common shareholders in the form of high dividends.

In late 1996, GMP struck a long term committment from Quebec Hydro (a Canadian utility) to purchase a guaranteed annual amount of electricity at fixed prices. Unfortunately, by mid 1997, electricity prices fell throughout North America. Green Mountain Power found themselves with a contract that required GMP to purchase electricity for a minimum of 10 years at prices that exceeded what the fair market was prepared to pay.

GMP approached the Public Utilities board and requested a series of annual increases to offset this cost. To the chagrin of Green Mountain Power shareholders, the rate base increase was completely denied.

As the company had little plant to calculate in its rate base, the PUB (public utilities board) was unsympathetic to their request. In their denial of the increase, the PUB stated that it would be inappropriate to increase the rate base by a high amount, merely to satisfy the dividend needs of common shareholders. For GMP, this represented catastrophy. The rate case was reviewed again by the Vermont Public utilities board in 1998 and until TODAY, was not resolved.

Green Mountain Power took as many steps as was humanly possible to overcome their inability to charge fair market prices for power. They cut the dividend from $2.12 per share (which had been maintained since 1994) to a modest $.55 per share. The reduction in the dividend served to push the share price down from a high of $33 in 1994 to its' present price.

Furthermore, this smallish utility had to spend a minimum of $1.3 million ($.23 per share annually) per year for the last four years seeking legal redress at the PUB and court levels....all to no avail.

Earnings per share fell dramatically in the ensuing mess. Green Mountain Power's earnings averaged $2.20 per share throughout the period of 1985 to 1996. By 1999, earnings had fallen to a modest $.46 per share. Investors understandably were concerned about the safety of the remaining $.55 in annual dividends. In 2000, the share price was bid down to a level that anticipated a complete elimination of the dividend.

For the last several years, this relatively efficient utility has been agressively working to reduce costs and increase efficiencies. Green Mountain Power sold their head office and rented cheaper space. They reduced head count by roughly half within five years. GMP now has a total of 195 employees. On a per customer basis, they have the leanest operation in North America. As well, GMP worked diligently to reduce total debt. Their total debt now stands at 42% of the balance sheet. This is very low in relation to most utilities today. There are truly no costs left to be wrung out of this company

At yesterday's current price of $8.25 per share, Green Mountain Power represented a utility that was very efficiently run, with a lean cost structure. The share price also reflected the likelihood that the dividend would be eliminated, and that there would be little chance for growth in revenues and profits. The return on shareholders equity had fallen to roughly 4%.

That was yesterday. At the close of business on November 13th 2000 (in a surprise decision), the Vermont Public Service Board changed their mind about rate relief. Green Mountain Power has been granted a 3.42% rate increase (commencing January 21st, 2001). This is the first rate increase obtained since 1996.

With such an efficient cost structure,I have calculated that virtually all of this rate increase will hit the bottom line like a ton of bricks. For 2001,(prior to the rate increase)I was forecasting that Green Mountain Power would be able to earn roughly $5 million U.S. This would have represented earnings per share of about $.90. The dividend would have been safe at $.55 per share.

I estimate that the rate increase will add roughly $744,600 in gross monthly profit. Assuming that Green Mountain Power continues to pay 30% tax, the rate increase will represent an additional $.85 PER SHARE ANNUALLY.

Green Mountain Power made several minor concessions as part of this agreement. The dividend rate of $.55 per share will be frozen until such time as GMP may convert short term credit facilities with long term debt or pays off short term debt completely. Total short term debt stands at a modest $6.7 million. I estimate that this can be paid off in full within the next 12 months.

For 2001, Green Mountan Power should generate earnings in excess of $1.75 per share. The dividend at $.55 per share will be covered threefold by earnings and will once again start to increase.

By any conventional analysis of its' peer group, Green Mountain Power appears to be the most inexpensive utility in North America for 2001. At current prices, the shares are selling for less than 5 times estimated 2001 earnings. The dividend rate of 6% is somewhat lower than typical utilities, but has ample room to rise by the end of 2001. When you add in a very lean cost structure, and a low debt to equity ratio, this company stands out as an immediate buy.

I forecast that Green Mountain Power shares may trade up to 8.5 to 9 times estimated earnings by the end of 2001. It should trade at a discount to its' peers due to its small size, and tarnished past. That being said, the misfortunes that investors experienced since 1996 were not the company's doing. Regulators are now permitting the company to earn a return on equity of 11.25%, which is equal to its' competitors.

An additional benefit may occur should interest rates decline. I do forecast a dramatic slowing of U.S. growth. Should growth rates decline to 2% next year, interest rates may fall by 1/2 of 1%. This would benefit all utilities.

In short, I wish to politely thump the table at this forum and suggest that you purchase these shares quickly. Once better known analysts reach the same conclusions as I have, the shares will surely rise. Should the shares sell for a p/e multiple of 8.5 times earnings by the end of 2001, fair value would be $15 per share. If the dividend rises to roughly 60% of net earnings (in 200), investors who purchase the shares at current prices may be able to earn a dividend yield of 12.7% annually by the end of 2002.

Catalyst

A significant rate increase has been allowed, which will virtually double earnings per share in 2001.