Over time, the best businesses to own are the ones that can employ large amounts of incremental capital at rates of return that are high and - ideally - increasing. This is the basis for value investments. Conversely, the last decade of near zero interest rates meant investors have had to chase returns, often at the cost of speculative ruin.
Now that interest rates have entered a period of secular increase, capital allocation has become more critical than ever. It is in in this context that the euphoric response to the DEWA IPO must be examined.
Perhaps, the company to compare DEWA to in the West would be Berkshire Energy, a utility that had earnings of $144 million in 2000, which increased to over $4 billion last year, an astonishing achievement for any company, let alone a utility one. Even more astonishing is that all of its earnings have been soaked up towards investing in renewables.
DEWA has embarked on a similar trajectory, which apart from the obvious advantages to the environment, has the financial benefit of a greater than doubling of margins over time. How then has DEWA embarked on a 90 per cent plus guarantee of dividend payouts (at 5 per cent, it is significantly higher than the what the utility sector in the West provides)? The answer is three-fold.
- Empower, which currently generates 9 per cent of Dewa’s earnings is set to be on a significantly higher growth trajectory, especially as urbanization of Dubai continues as outlined in the Urban Plan of 2040.
- Empower itself is set for an IPO as early as this year, further contributing to the valuation growth and enterprise value of the company.
- Independent power plants will contribute greater marginal earnings growth whilst reducing capex costs.
High on valuation
Investors who worry about pricing and the potential runup of the stock price post-IPO miss the essential point - pricing is not valuation. Valuation is about digging through a business, understanding cashflows and risk, and then attaching a number to that enterprise. This is why the comparison to Berkshire Energy is appropriate, because it highlights the advantages of a business that is well run, despite the disruptive changes that clean energy requirements bought into the fray.
It does not require sophistry in thinking to understand that DEWA - with its growth markets, its return on equity and high dividend rate with the potential of further capital gains through the Empower IPO - is the fairest of them all on DFM right now. Add to the fact that risk-free interest rates are rising, along with a deflating equity and speculative bubble in the rest of the world, and the answer is clear as a bell for those who can see.
Buffett shows how it’s done
DEWA is a cornerstone of any investment portfolio. Ideally, even the dividends that it pays out should be reinvested into the company for the foreseeable future. It is that rare combination of a company that possesses not only above average business economics but, equally important, directed by people who possess the management capabilities. It is this combination that will likely result in an above average marginal rate of return on capital even as interest rates rise, suggesting not only the soundness of capital allocation, but also opportunities that are latent in the sector as it continues its transformation towards more efficient power sources.
All one has to do is to look at Berkshire Hathaway by comparison to glimpse at the growth potential that is there in what has historically been considered a non-growth sector. Over the last decade, everyone has focused on the technology sector, and whilst that emphasis is unlikely to recede, there is always a place for defensive stocks that have a margin of safety, a fundamental principle embraced by Warren Buffett, easily the greatest investor of all time.
DEWA offers that margin of safety with room to spare. That is the premise behind value investing, and at the end of the day, all investing is value investing. The ability to seek a bargain.
Ben Graham stated that: “Investment is most intelligent when it is most businesslike”. The DEWA offering, similar to some others that are lined up, are all driven by that ethos of business-like capital allocation. All investors need to do is show up.
