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Hawaiian Electric Industries: Don’t Count on Its Dividend

By Jim Fink on August 17, 2010


Master limited partnerships are reporting strong second-quarter results; roughly 70 percent paid out higher distributions this quarter than a year ago. Based on guidance from most of our favorites, distribution growth should accelerate in 2011.

Elliott Gue, MLP Profits

The more I learn about energy master limited partnerships (MLPs), the more impressed I am with their sustainable and growing cash distributions. Not all dividend-paying companies have similar strength. Take, for example, Hawaiian Electric Industries (NYSE: HE).

Hawaiian Electric: Is it a Utility or a Bank?

It’s pretty weird for an electric utility holding company to also operate a bank, but that’s the situation in Hawaii. Hawaiian Electric Industries provides electricity to 95% of Hawaii’s population (i.e., pretty much everywhere except the island of Kauai) and also owns American Savings Bank, the third-largest in Hawaii. Constance Lau is not only CEO of the holding company, but Chairman of the electric utility subsidiary and Chairman and CEO of the bank subsidiary. Talk about centralized power! 

Furthermore, aren’t the electric utility and banking industries quite different and don’t they require different management expertise? Based on the fact that she is CEO of the bank but not of the electric utility, I figure that Ms. Lau’s expertise is more on the banking side. But I have to believe that she is simply wearing too many hats to do a good job at them all.  The company released second-quarter financials last week that back up my hunch. Earnings per share were $0.31, up 82% year-over-year.  But most of the profit improvement came from the bank:


Q2 2010

Q2 2009

% Change


$16.1 million

$4.0 million


Electric Utility

$17.6 million

$15.5 million


So far in 2010, the bank’s return on assets and net interest margin are both above the average of its peer banks. The bank was also recently voted “Hawaii’s Best Bank” by the readers of the Honolulu Star-Advertiser newspaper.

Hawaiian Electric Has an Earnings Problem

In contrast, the electric utility – which has a virtual monopoly — can’t even earn the return on equity (ROE) that the Hawaii Public Utilities Commission (PUC) has authorized it. In the 12 months ending June 30, 2010, the company’s consolidated utility ROE was 6.81%, far below the 10.5%-10.7% authorized.

A large part of the problem has to do with the multiple-island structure of Hawaii. The islands are so far apart that they lack physical utility connections between each other (constructing interisland undersea cables is under consideration, but is a long way off). Consequently, each island must have its own electricity generating facilities and be self-sufficient. This prevents Hawaiian Electric from benefiting from the economies of scale enjoyed by virtually every other electric utility in the U.S. Running three completely separate utility infrastructures causes its costs of operation to be much higher than that of the typical utility and its return on equity suffers as a result.

Of Hawaiian Electric’s three separate utility operating companies, the worst performing is Maui Electric:

Operating Company

Authorized ROE

Actual ROE

Hawaiian Electric (Oahu)



Maui Electric (Maui, Molokai, Lanai)



Hawaii Electric Light (Big Island)



Dividends Not Covered By Earnings

The company pays a nice annual cash dividend of $1.24 per share (currently 5.2%), but its earnings have not been sufficient to cover it for the past three fiscal years:





Trailing 12 Months

Earnings Per Share





Dividends Per Share





This past February in the Q4 2009 conference call, CFO James Ajello addressed the earnings shortfall by saying:

We will be financing uncovered portions in holding company expenses with equity issuances through our dividend reinvestment program and via short term borrowing.

Relying on borrowed money and hoping shareholders elect to forego the cash dividend by reinvesting in more shares does not reassure me that the dividend is secure. It’s no wonder that Roger Conrad, editor of the Utility Forecaster investment service, has placed Hawaiian Electric on his “Dividend Watch List” for a possible dividend cut.  But on August 9th the company announced it was maintaining the $0.31 quarterly payout for at least one more quarter. In its related 10-Q filing (p. 51), the company stated that it has no plans to cut the dividend, but didn’t sound very convincing:

The payout ratios for 2009 and the first six months of 2010 were 137% and 102%, respectively. HEI currently expects to maintain the dividend at its present level; however, the HEI Board of Directors evaluates the dividend quarterly and considers many factors in the evaluation, including but not limited to the Company’s results of operations, the long-term prospects for the Company, and current and expected future economic conditions.

Looking backward, the company has never cut its dividend since at least February 1988.  Looking forward, mean earnings estimates from First Call have the company earning its $0.31 per share quarterly dividend each quarter continuously through Q2 2012.

Earnings Are Set to Improve

Three factors suggest that the utility’s earnings will improve in coming quarters. First, Hawaii’s economy is based largely on tourism and the tourism industry – which is one of Hawaiian Electric’s largest customer segments — continues to recover from the recession. Hawaii’s unemployment rate in June fell to 6.3%, its lowest level in more than a year and a third lower than the overall U.S. unemployment rate of 9.5%.

Hawaii is Going Green

Second, Hawaii is currently the most oil-dependent state in the U.S., relying on imported oil for 90% of its energy needs. Two refineries, one owned by Chevron (NYSE: CVX) and the other by Tesoro (NYSE: TSO), service the entire state. To eliminate this extreme oil dependence, the state and the U.S. Department of Energy have joined forces in a “Clean Energy Initiative” aimed at transforming Hawaii into a “world model for energy independence and sustainability.” Goals of the initiative include meeting 70% of Hawaii’s energy needs by clean energy sources by 2030, and 40% by renewable energy sources. Hawaii has sunshine 70% of the time and some of the strongest ocean waves in the world, so it has significant natural resources to generate energy. 

Anyway, the point is that the state will be encouraging Hawaiian Electric to increase its rate base by investing in new clean energy generating facilities. Hawaiian Electric will be continually filing requests for rate increases with the Hawaii PUC to pay for the equipment upgrades (including a profit margin) and the PUC has a history of granting such increases. Roger Conrad rates Hawaii’s regulatory climate as “Good” for utilities. Bottom line: the larger Hawaiian Electric’s rate base, the higher rates it can charge, which means higher profits.

Ironically, higher profits from increased investment could actually endanger the dividend in the short-term. Investment requires capital expenditures, which eat up cash flow and reduce the amount of “free cash flow” available to pay dividends. One definition of free cash flow is cash flow from operations (CFFO) minus net capital expenditures (CAPEX):





Trailing 12 Months


$217 million

$260 million

$284 million

$179 million


$218 million

$282 million

$305 million

$259 million

Free Cash Flow

-$1 million

-$22 million

-$21 million

-$80 million

If the Clean Energy Initiative requires Hawaiian Electric to substantially increase is CAPEX expenditures to build new infrastructure, free cash flow could remain negative for years to come, which could make it difficult for the company to find the money to pay the dividend.  In contrast, the negative effect of CAPEX on earnings is much more muted than it is on free cash flow. Earnings are reduced only by a depreciation charge, not by the full amount of CAPEX. However, the depreciation charge covers all of the company’s equipment, not just the equipment purchased in a given year, so it varies whether depreciation or CAPEX is larger in a given year.

Rate Decoupling is a Good Thing

Third, this past February the Hawaii PUC authorized “electric rate decoupling,” which allows Hawaiian Electric to earn its authorized ROE regardless of the amount of electricity actually used by consumers. In the past, a utility was authorized to charge a certain rate per kilowatt hour that, based on forecasts of electricity usage, would permit the utility to earn certain ROE. If electricity usage came in lower than expected, profits would suffer and vice versa.

Under decoupling, electricity rates are automatically adjusted so that a utility earns its authorized ROE regardless of electricity usage. So, if usage is below forecasts, rates are adjusted upward and vice versa.  Not only does decoupling encourage utilities to promote energy conservation, but it also provides utilities with a much smoother and predictable earnings stream. As CEO Lau said during the last conference call:

As we implement sales decoupling, we are targeting a significant improvement in our return to narrow the gap between our earned and allowed ROEs.

Credit Rating Improvement

In fact, on July 30th Moody’s changed its rating outlook for Hawaiian Electric from negative to stable based on the anticipated adoption of rate decoupling:

The ratings affirmation and outlook change reflects the progress being made by the company and various stakeholders to transform the regulatory framework for HEI’s electric utilities to a decoupling structure that will reduce sales volume risk and produce more timely recovery of invested capital and operations and maintenance (O&M) costs.

The stable rating outlook at HEI incorporates our belief that the regulatory transition underway in Hawaii will proceed in an orderly fashion with the Hawaii PUC issuing the final decoupling order during 2010.

Based on the stock’s price action, it doesn’t appear that investors expect the dividend to be cut. Since the beginning of the year, Hawaii Electric has significantly outperformed both the electric utility index and the S&P 500:

Source: Bloomberg

Invest in Texas, not Hawaii

Personally, I don’t want to invest in companies like Hawaiian Electric that haven’t raised their dividend in more than twelve years and that suffer the risk of a dividend cut. Instead, I am looking at energy MLPs for solid and growing cash distributions. For example, Roger and Elliott’s MLP Profits investment service currently likes Texas-based Enterprise Products Partners (NYSE: EPD) which offers a 6.3% annual yield. On July 26th, Enterprise reported a 44% increase in earnings and raised its cash distribution by 5.5%, the 24th consecutive quarterly increase.

I’ll go to Hawaii for a beach vacation, but not for investments. I’m sticking with a Texas MLP.


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