The days of dreamy dividends are over. Utilities nationwide are feeling the squeeze of slowing sales amid rising energy prices, and seemingly untouchable dividends are getting the guillotine. But refocusing finances elsewhere isn't always a bad thing, and could ultimately give investors more bang for their buck. Let's take a look at two utilities that recently revised dividends, three that haven't, and decide which stocks deserve a slice of our portfolio.
Why are all the dividends dying?
Companies don't reduce dividends because of a bad quarter – or for that matter, even a bad year. Income investors go gaga for growing dividends, and any corporation that cuts theirs also risks cutting itself off from a chunk of its shareholders.
Nonetheless, shrinking sales forecasts are forcing many utilities to rethink their own investments. A January report from the Department of Energy estimates that electricity use will ooze forward at a miserly 0.58% compound annual growth rate for the next decade.
This means that utilities will have to focus on their bottom lines instead of relying on top-line growth to push profits higher. And bottom-line growth (i.e. efficiency) requires the same thing dividends do: cold hard cash.
Dividend haircuts... looking good?
As Q4 earnings reports continue to stream in, two corporations announced massive dividend cuts as part of larger financial restructuring initiatives. Exelon (NYSE: EXC ) will cut its dividend by 40% starting in Q2 2013, while Atlantic Power (NYSE: AT ) plans to slice its monthly dividend by 66% starting in March.
The two utilities' CEO's had uncannily similar statements on the matter, citing macro concerns, a renewed focus on growth, and a more long-term perspective as key reasons for their dividend haircuts. Buzz words like "flexibility," "consistent with our outlook," "enhance," and "attractive total return" call for plenty of reading between the lines, but each executive delivered an underlying and undeniable message: times are changing, and we're changing with them.
Before the reduction, Exelon and Atlantic offered yields around 7% and 10%, respectively. With the average yield for utilities clocking in at 4.1% annually, these utilities' offerings were easily overgenerous considering their cash dividend payout ratios.
Dividends without end?
Canada-based Brookfield Infrastructure Partners (NYSE: BIP ) currently offers a $0.43 quarterly dividend (around 4.3% yield) that has grown around 160% since the utilities and timber holding company first launched its IPO in 2008. Its dividend isn't alone in growth – its stock has jumped 128% in the same time period, delivering quarterly earnings and longtime growth for shareholders. Motley Fool's Inside Value found this diamond in the rough back in its beginnings, but its current P/E ratio of 77 has pushed its stock up enough to put any new purchases on the back burner. Even the best dividends have a price.
FirstEnergy's (NYSE: FE ) dividend is, unfortunately, an example of silly status quo. After it merged with Allegheny Energy in 2011, FirstEnergy became one of the largest utilities nationwide by customer size. But customers' consumption can change, and FirstEnergy's sales have suffered over the last two years even as the company has kept its dividend distributions steady. Fast forward to today: FirstEnergy has one of the highest dividend yields around (5.5%) – with one of the worst cash dividend payout ratios in town. If its dividend doesn't get slashed, don't expect any financial favors to come from this company's cash flow.
Last but not least, Ameren (NYSE: AEE ) offers a unique take on the dividend dilemma. When most utilities hung on to their dividends through the worst of the Great Recession (and felt their finances squeezed accordingly), Ameren went ahead and cut its dividend by 40%. With its books balanced, the company currently enjoys a 4.8% yield with one of the best cash flow positive dividend payout ratios around. Ameren's focusing on its regulated division and, if it can trim off its generation assets without too much trouble, could become a formidable cash cow in the future.
Foolish bottom line
A steady dividend doesn't make a company bad, and a slashed dividend shouldn't automatically earn brownie points. Either decision is part of a corporation's larger strategy to increase value, and a dividend of any size is no replacement for excellent management and solid fundamentals. Exelon and Atlantic earn bullish brownie points for pushing capital elsewhere, while Brookfield and Ameren get stars for sustainability. FirstEnergy investors shouldn't necessarily run for the hills, but its current dividend doesn't make the cut.
As the nation moves increasingly toward clean energy, one company in this space that is perfectly positioned to capitalize on having the largest nuclear fleet in North America is Exelon. This strength combined with an increased focus on renewable energy, along with its recent merger with Constellation, puts Exelon and its best-in-class dividend on a short list of top utilities. To determine if Exelon is a good long-term fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for instant access.