Utility company PPL Corp. (PPL 1.60%) had a fairly lackluster 2016, with its stock giving shareholders a total return of 4% that came exclusively from the dividends it paid out during the year. After such a quiet 2016, investors in the company once known as Pennsylvania Power & Light wonder whether the coming year will bring better performance -- or a big surprise that could hurt their returns in 2017. In particular, three issues facing PPL will play a major role in its stock does this year.
Image source: PPL.
1. Will interest rates keep rising?
Utilities stocks performed strongly in the first half of 2016, and to a large extent, low interest rates were the cause. In late 2015, the Federal Reserve raised short-term rates for the first time in years, and at the time, investors expected that further increases would come. Yet by early 2016, it became clear that the economic recovery was more sluggish than many had expected, and that led the Fed to ease off on tightening monetary policy. March, June, and September came and went without a Fed Funds rate increase, and rate-sensitive utilities like PPL celebrated.
However, in the second half of the year, PPL stock gave back its early year gains as investors became increasingly convinced that stronger economic conditions would force the Fed's hand. Sure enough, the central bank made moves to raise rates in December, and Fed officials now expect three rate hikes in 2017 to add to the upward pressure. If that happens, then shareholders in PPL and other utilities will have to deal with the historical trend toward lower share prices in times of rising rates.
2. Will PPL boost its dividend?
PPL has a solid dividend, and it also has a history of dividend growth that investors like to see. Currently, the stock yields 4.4%, and investors currently get $0.38 per share each quarter in their dividend payment. Moreover, PPL has a 15-year track record of raising dividends each and every year, with the typical payout increase coming in early February.
The key question for PPL shareholders isn't so much whether the utility will raise its dividend, because the answer is almost certainly yes. But what's unclear is by how much PPL might boost its quarterly payout. Ever since the financial crisis in 2008, the utility company has been a lot stingier with dividend increases, culminating in a tiny $0.0025 increase last year that represented less than a 1% boost. With a payout ratio of 56%, PPL could afford to make larger dividend increases, but its recent history suggests that it's unlikely to do so. PPL investors will almost certainly have to content themselves with another token payout increase in 2017, especially given the adverse rate environment.
3. How will PPL handle Brexit?
Many investors didn't realize that PPL has extensive operations in the U.K. until the Brexit scandal brought the issue front and center. Yet its U.K.-based Western Power Distribution and Central Networks units, which together were responsible for the majority of PPL's earnings in the first half of 2016, face the difficulty of a dramatically weaker British pound. As a result, U.K. division profits will translate into fewer U.S. dollars, and that in turn will hurt PPL's overall results.
Late last year, PPL CEO Williams Spence presented the company's strategy to overcome negative impacts from Brexit and still hit its long-range earnings targets. In particular, PPL has decided to expand its currency hedging program through 2018, and although that will cost the company about $0.05 per share in earnings this year, it should insulate the utility's British profits if the pound declines further. The downside is that if the pound recovers sharply, PPL won't benefit, but that's a trade-off that the company seems willing to make right now.
PPL will have to address all three of these questions to satisfy investors and produce better results in 2017. If things don't go as expected, then PPL stock could do even worse than the modest rise it posted last year.
