introduction

I am writing this article because I received a request to cover Hawaiian Electric Industries Inc. (NYSE: IT) and because I was really interested in seeing if the stock could be a suitable addition to my dividend growth portfolio. The company has near-zero stock dilution, its dividend yield is 3.4%, the stock has delivered a lot of value to its investors, and investors are recession-proof. Unfortunately, dividend growth is very low and I don’t know if investors are interested in buying a combination of a bank and a utility, which is HE.

In this article, I will share my thoughts on this somewhat atypical company.

Is it a bank? Is it a utility?

Hawaiian Electric Industries, Inc., through its subsidiaries, is engaged in investing in electric utilities, banking, and renewable/sustainable infrastructure in the State of Hawaii. It operates in three segments: Electric Utility, Bank and Other. That’s right, the company is a utility company AND a bank.

According to FINVIZ, the Electric Utilities segment is engaged in the generation, purchase, transmission, distribution and sale of electricity in the islands of Oahu, Hawaii, Maui, of Lanai and Molokai. Its renewable energy sources and potential sources include wind, solar, photovoltaic, geothermal, wave, hydroelectric, municipal waste and other biofuels. This segment serves suburban communities, resorts, US Armed Forces installations and agricultural operations.

The Banking segment operates a community bank that provides banking and other financial services to consumers and businesses, including savings and checking accounts; and loans including residential and commercial real estate, residential mortgage, construction and development, multifamily residential and commercial real estate, consumer and commercial loans. This segment operates 42 branches, including 29 branches in Oahu, 6 branches in Maui, 4 branches in Hawaii, 2 branches in Kauai and 1 branch in Molokai.

The figures in the screenshot below are current as they come from an investor presentation dated March 16, 2022.

First, I start with the utility part of the business, which accounts for 64% of net income.

usefulness

Like all major US utilities, the company is looking to go “green.” By 2030, the company wants to reduce its carbon emissions by 70% compared to 2005. By 2045, the company is aiming for “net zero”, ie 5 years ahead of the Paris objective.

Management wants to achieve this by closing its last coal-fired plant in September this year, removing and reducing the use of fossil fuel generating units, adding 1 GW of renewable energy generation capacity, increasing the rooftop solar energy by 55%, developing geothermal energy and encouraging the use of clean, low-cost energy.

Hawaii is one of the best places to do this. 21% of all residential customers already have a rooftop solar system, while 37% of single-family homes on Oahu have a rooftop solar system. In this case, the company uses distributed energy resources (“DER”) to enable people without solar to benefit from shared solar. After growing residential photovoltaic installations by 39% per year through 2015, HE forecasts longer-term growth rates in the range of 7%.

The company excels in cost control. Adjusted operating and maintenance (O&M) costs increased from $422 million in 2019 to $412 million in 2021. This figure was slightly higher due to storm-related costs and $42 million in credits on customer invoice.

Before showing you the big picture, let’s take a look at its banking segment, as it contributes about 36% to total net income.

The bank

American Savings Bank is one of Hawaii’s largest financial institutions with $9 billion in assets. The bank has a loan portfolio of 55.2 billion. 44.6% of this amount comes from residential mortgage loans. 20.3% are commercial real estate loans. 10.4% comes from commercial and industrial loans. 93% of its loan portfolio is secured by real estate.

The combined company

The “fun” thing about HE being both a bank and a utility is that when trading, these two are exact opposites. Utilities are “risk free” assets, while banks are “risky”. Risk-off means defensive, in this case. Rising rates hurt public services but benefit banks. Lower rates hurt banks but benefit public services.

The backtest below shows that including dividends, HE has returned 8.36% per year since the 1990s. This beats the utility ETF (XLU) and the S&P 500. The Sharpe ratio and the Sortino ratio are similar . The market correlation, however, is much lower. This makes sense insofar as the company is a public utility exposed to the banking sector, which behaves differently in certain economic environments, as I have already briefly mentioned.

I’m not surprised by the outperformance. HE’s net income growth was strong. Over the past 10 years, we are seeing 65.4% growth in total net income. Net earnings per share are 46.1%, which tops many utilities. Why? Because HE doesn’t dilute existing stocks as much. In 2017, the company had 108.75 million shares outstanding. In 2021, that number was 109.28 million. This is a rate dilution of 0.1% per year because HE does not need equity financing due to its bank income.

And even free cash flow is barely positive, which – believe it or not – is a positive thing because most utilities can’t maintain positive free cash flow due to renewable energy investments. In HE’s case, the company needs about $160 million to pay its 3.4% dividend, which means net debt is only growing slowly – after all, free cash flow is already investments in renewable energies. And it is indeed the case. Net debt (2021 is not visible for some reason) is expected to grow from $2.0 billion in 2020 to $2.5 billion in 2024. This represents growth of 4.6% per year, which is below the long-term earnings per share growth rate of approximately 8%.

Unfortunately, the dividend is somewhat disappointing.

Dividend & Valuation

The dividend yield of 3.4% is decent. This is slightly above the industry median of 3.2%. The current yield of the S&P 500 is 1.4%, which means investors are getting a 200 basis point premium, which is not that common in the current environment. Even high-yielding stocks like PepsiCo (PEP) are now yielding less than 2.7%.

The problem is that the dividend growth rate is absolutely terrible. The Seeking Alpha chart below shows the company’s dividend growth history. In 1998, the company grew by 1.6%. Then it didn’t increase for over a decade when the dividend was increased again by 3.2% in 2019.

Therefore, the dividend yield is mainly determined by the share price. The total return outperformance came with side effects: dividend growth couldn’t keep up with capital gains. The stock was returning about 6% before the Great Financial Crisis. It then gradually fell to the present value of 3.3%, which includes four years of rising dividends.

Going forward, the company seeks to keep dividend growth in line with earnings growth and a payout ratio of 60-70%. This implies that as investments in renewables decline, we could see higher dividend growth. This is good news because it would make an already good return more attractive.

In terms of valuation, we are dealing with a market capitalization of $4.6 billion and a net debt of around $2.4 billion. HE also has pension (and related) liabilities of $400 million. Adding it all up gives us an enterprise value of $7.4 billion. This translates to an EBITDA of 11.2x using an average EBITDA result of $660 million.

This assessment is “fine”. It’s not undervalued and it’s not overvalued either. It’s the kind of valuation that lets you buy the stock immediately in case you like what HE brings to the table.

Carry

Hawaiian Electric is an unusual company and I can’t believe I haven’t reviewed it sooner. The company is not just a utility company, but a company engaged in electricity utility operations and banking operations. This essentially gives investors exposure to the heartland of Hawaii in a somewhat defensive manner. The electric utility business is strong and is benefiting from a transition to renewable energy which is accompanied by solid earnings growth. The banking sector mainly focuses on mortgages and related loans. Almost all of them are secured by real estate.

The 3.4% return is decent in today’s environment. I expect dividend growth to stay close to 3-4% per year going forward after a 10-year dry streak ended in 2018.

The problem is that I’m not sure there’s a must-have item here. Performance is decent, but other utilities offer similar performance. I also don’t know if there’s enough growth potential in Hawaii. It also needs to be seen if HE can outperform its peers, as most of its outperformance occurred before the Great Financial Crisis.

However, this does not mean that the stock is not a suitable investment. If you like dividend yield and (expected) growth rate, HE is the stock for you. It’s not volatile and it’s a business that lets you sleep well at night without sacrificing a lot of upside potential.

(Disagree? Let me know in the comments!

PS: since I mentioned that there are good alternatives. Here are two alternatives that I recently covered. I have both in my dividend growth portfolio:

Duke Energy (DUK) – article

Xcel Energy (XEL) – article