Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Pity PPL (PPL 0.76%) stockholders. Over the past year, shares of this Anglo-American gas and electricity utility have gained less than 2%, despite the broader market growing 13%. But there's good news, too -- over at investment bank Jefferies & Co., they think it's time for PPL to shine.
Jefferies sees a towering opportunity in electric utility PPL Corp. Image source: Getty Images.
1. Power to the PPL
As reported this morning on StreetInsider.com (requires subscription), Jefferies upgraded shares of PPL Corp from hold to buy this morning, and raised its price target on PPL stock to $42. If Jefferies is right about its new target, PPL shareholders stand to enjoy about an 11.5% gain in their stock price over the next year. Add a market-beating 4.2% dividend yield (twice the 2.1% yield of the broader S&P 500), and PPL promises to return a nearly 16% gain for investors.
2. How PPL got unplugged
But if all this is true, then why has PPL stock been lagging so much lately? As Jefferies hypothesizes, there's some risk in owning PPL stock, which does business in both the U.S. (71% of annual revenue, according to data from S&P Global Market Intelligence) and in the U.K. as well (the other 29%). Vagaries in the exchange rate between the U.S. Dollar (USD) and the Great British Pound (GBP), believes Jefferies, explain why PPL shares sell for a "12% discount."
A "12% discount" to what, precisely, is unclear from StreetInsider's write-up, but it's instructive to note that both The Southern Company (SO 1.10%) and Dominion Energy Midstream Partners (NYSE: DM), two companies that name PPL as a competitor, sell for more expensive price-to-earnings ratios (17.6 and 20.4, respectively) than PPL's P/E of 14. In Jefferies' opinion, though, there's no good reason for PPL stock to be valued so cheaply.
3. Why it might be time to plug back in to PPL
Over the past four months, the GBP has appreciated about 6% in comparison to the USD. That sounds like good news for American PPL stockholders, because it means that profits earned in the form of GBP lately convert to more USD back home in the U.S.
US Dollar to British Pound Exchange Rate data by YCharts.
It also means, however, that if and when exchange rates turn around and the dollar strengthens relative to the pound, PPL's dollar-denominated profits might decline. This seems to be what investors are worrying about in avoiding PPL stock.
And yet, Jefferies thinks such worries are misplaced. As StreetInsider describes the analyst's reasoning, PPL's earnings are "hedged 100% through 2019" and "largely hedged through 2020." If there's any risk of the GBP devaluing, and torpedoing PPL's USD profits, it's a risk still at least 18 months off, and not something investors necessarily need to worry about today. (Plus, PPL could always continue to hedge its currency risk in years after 2020 as well.)
The upshot for investors
Accordingly, Jefferies thinks PPL stock is currently undervalued and should be bought, and that's a reasonable argument. As the analyst points out, analysts expect that PPL will grow its earnings at somewhere between 4.5% and 6% over the next five years, and PPL stock pays a dividend of 4.2%.
Combined, that still makes for a total return of only about 10% for PPL stock, which doesn't necessarily make the stock cheap relative to its 14 P/E ratio. And yet, "we struggle to find [any other] regulated story growing EPS at 5-6% and paying a 4.2% yield," says Jefferies.
For comparison, Southern Company pays a superior dividend (4.9%), but most analysts see it growing at only 4.5% or so over the next five years -- and Southern Company sells for a P/E ratio 25% higher than PPL's. Dominion Energy Midstream's earnings prospects look even shakier; its dividend is only 3.9%, and its P/E is 46% higher than PPL's!
If a good dividend, decent growth prospects, and a great stock price are what you're looking for in a dividend stock, PPL just might be the utility stock for you.
