Stock pick: Teco Energy

It pays a 5.29% yield while you wait for better earnings in 2014.

By Jim J. Jubak Aug 21, 2013 11:23PM

Power station ©, Flickr, Getty ImagesThis hasn't been the best of markets for Teco Energy (TE) -- along with most other utility stocks. The shares are down 11.04% in the last three months, as of Tuesday. Over the last month they're down 5.55%. That's slightly worse than the 4.84% drop for the Dow Jones Utility Index. Earnings from operations for 2013 look likely to decline by about 16% from 2012. And the company’s coal business looks to be facing another year of low coal prices and sluggish demand.

But that plethora of bad news has driven the yield on these shares to a hefty 5.29%. And the rest of 2013 and especially 2014 looks much more promising for the utility, as a restructuring designed to shed non-core businesses and an improving Florida economy take effect.

That’s why I added the stock to my Dividend Income portfolio on Tuesday. I'd put a 12-month target price of $19 a share on this stock. That's a potential gain of 17.3% from the August 20 close and with the current 5.29% yield makes an attractive total return package. (For more on dividend stocks in this market and utility stocks in particular see my post from earlier this week.)

Teco's biggest business unit is Florida's Tampa Electric. That's a good business for a regulated utility now, because with the recovery in Florida's economy Tampa Electric's customer base is forecast to grow by about 1.2% to 1.4% in 2013. And Florida's utility regulators have been, historically, some of the most "generous" in the country. In its last rate increase request, Tampa Electric received approval for an 11.25% return on equity.

Teco is in the midst of a restructuring that looks to sell non-core assets and to reinvest in the core regulated business. So far that has resulted in the sale of Teco's operations in Guatemala -- and the pending purchase of New Mexico Gas with its 500,000 regulated gas customers for $950 million.

The big question for Teco -- and for investors -- is what will happen in the next year to the company's big non-core asset, Teco Coal. Historically the coal business has provided about 20% of the company’s operating earnings, but that hasn't been the case recently -- as falling coal prices and volumes have blasted the coal-mining sector. In the second quarter Teco Coal reported operating earnings of just $700,000 versus $12 million for the second quarter of 2012.

Teco Energy has said that it is looking to sell the coal business -- if it can get an attractive price. That would seem unlikely in the current market except that in November 2011 Teco Coal announced the addition of 65 million tons of metallurgical coal to the proved reserves at its Appalachian mines. Metallurgical coal is clearly the most attractive part of the coal market, and it's likely to recover more quickly than thermal coal with growth in the global economy.

Teco Energy's 88 cents a share dividend for 2013 will be flat with 2012 and since the payout ratio is a very high 92%, I don't think investors can expect much if any dividend increase in 2014. The key issue for the company is when/if it will sell its coal business. A sale of that asset, which would remove a drag on earnings and give the company cash to reinvest in is regulated business, would result in a resumption of dividend growth. And a sale of Teco Coal would remove a problem that hangs over the stock.

I think an investor in Teco is waiting for 2014, but with that 5.29% dividend, you are being paid to wait.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Teco Energy as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio.

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