Investors searching for high yields are often drawn to utility stocks. Whether in the business of distributing electricity, natural gas, or even water, utilities generate predictable revenue and earnings. And since they usually double as cash cows, these businesses can return healthy amounts of cash to shareholders through dividends.

While investors are more familiar with integrated power generators and energy providers such as Duke Energy (NYSE:DUK) and Dominion Energy (NYSE:D), one dividend stock in the utility space that doesn't seem to garner enough attention is NiSource (NYSE:NI). The much smaller and more focused company is coming off a strong 2017 campaign, just increased its dividend 11%, and has prepped shareholders to expect continued growth for the foreseeable future. Here's what you need to know about the under-the-radar utility stock.

Two power towers and transmission lines against a blue sky.

Image source: Getty Images.

The business

NiSource operates as a fully regulated gas and electric utility. It serves 4 million customers in seven states and covers major American cities from Chicago to Pittsburgh. That the business is 100% regulated is a particularly relevant detail for investors to consider. Why?

Regulated markets -- which now comprise the great majority of all electricity, natural gas, and water distribution in the United States -- serve as a win for customers and utilities alike. While growth rates are slow to modest in regulated markets, that's made up for by the fact that growth is guaranteed. Long-term capital investments that improve and maintain distribution infrastructure serve as sacrifices at the altar of state regulatory authorities, which then reward utilities with the ability to charge their customers incrementally higher rates that provide a specific rate of return.

Generally speaking, the more a utility invests the higher the increase in rates it can charge in future periods. Roughly 75% of the company's capital investments are recovered within 12 months, although the remainder can take several years. Therefore, a steady stream of capital investments is best -- even better if they're steadily increasing. That's why NiSource plans to spend $1.7 billion to $1.8 billion on infrastructure improvements in 2018, up from $1.3 billion in 2014. That level of commitment promises to build on a solid performance last year. 

A hand holding a light bulb with a dollar sign in it.

Image source: Getty Images.

By the numbers

While growth is guaranteed for regulated utilities, NiSource turned in a strong year of operations in 2017 compared with the previous year. Note: NiSource labels its preferred earnings metric "operating EPS," but it's really the same thing as adjusted EPS.

Metric

2017

2016

% Difference

Revenue

$4.88 billion

$4.49 billion

8.6%

Operating expenses

$3.96 billion

$3.63 billion

9%

Operating income

$910 million

$858 million

6.1%

EPS

$0.39

$1.02

(61.8%)

Operating EPS

$1.21

$1.09

11%

Data dource: NiSource.

One of those numbers looks alarming, but there's an innocent explanation.

Historically speaking, there hasn't been much of a difference between net EPS and adjusted EPS in the company's financial reporting, but 2017 was an unusual year. NiSource took a $161 million charge for adjusting its tax holdings related to the new corporate tax rates and calculated that it saved $111 million in interest expense from refinancing close to $1 billion in long-term debt at more favorable rates. In other words, the operating EPS metric is a better indicator of the business' performance in 2017. 

While year-over-year growth in operating expenses outpaced growth for operating income, the bulk of the increase in costs was from depreciation, operating and maintenance expense, and taxes. There's not much NiSource can do about depreciation, although it will see a reduction in tax expense in 2018 thanks to the new corporate tax rates. Meanwhile, capital investments in infrastructure will, over the long-term, decrease operating and maintenance costs thanks to smart meters and fewer repairs. 

The company expects to grow both its operating EPS and dividend 5% to 7% annually through 2020. It's off to a good start in 2018. Management boosted the dividend 11% and has guided for up to 9% year-over-year growth in operating EPS for the full year. 

So how does NiSource stack up to better known peers Duke Energy and Dominion Energy?

A hand drawing a big fish about to eat many smaller fish.

Image source: Getty Images.

What about larger peers?

There are quite a few differences between the trio. The first thing that will jump out at investors is size: Duke Energy is valued at $47 billion, Dominion Energy at $52 billion, and NiSource at just under $8 billion. As is often the case with regulated utilities, size matters. Case in point: The larger peers offer shareholders much more generous dividends.

That said, the three companies are a little closer on most valuation metrics. Here's a side-by-side comparison:   

Metric

NiSource

Duke Energy

Dominion Energy

Market cap

$7.7 billion

$47 billion

$52 billion

Forward P/E

16.8

15.2

17.0

PEG ratio

3.2

3.8

2.6

EV/EBITDA

11.7

10.6

13.3

Dividend yield

3.4%

4.7%

4.6%

5-year share returns

106%

7%

28%

Data source: Yahoo! Finance.

Judging on dividends alone, investors may be inclined to continue overlooking NiSource. But there's something else to consider.

While both Duke Energy and Dominion Energy own and operate regulated utility businesses, they also own power generation businesses. The vertical integration isn't necessarily a bad thing, but it exposes shareholders of both companies to a different basket of risks -- including some that may matter more in the near future.

For instance, decarbonization efforts (and related regulations) and distributed renewable energy are quickly changing the power generation mix of the United States. That could sting Duke Energy, which generates 27% of its power from coal, and Dominion Energy, which relies on coal for 17% of its generation. Both companies are also heavily reliant on nuclear energy, at 27% and 32% of their respective generation. Considering the United States generates 19% of its electricity from nuclear power, the two could be viewed as overexposed to atomic energy. That could become a problem when the bills come due for decommissioning.  

Conversely, with NiSource, investors aren't nearly as exposed to the risks from power generation. As trends change, the company can adjust its purchases of power accordingly and with much less pain than vertically integrated energy companies. That fact, and being relatively equal on major valuation metrics compared with its larger vertically integrated peers, might allow income investors to forgive the lower yield.

A woman standing in front of a chalkboard with question marks drawn on it.

Image source: Getty Images.

Should you buy NiSource stock?

NiSource doesn't garner as much attention as larger utility stocks, but it's a formidable dividend stock that should at least be on investors' radars. Whether or not it belongs in your portfolio depends on your long-term strategy. The company is growing, but at a moderate pace. It offers a dividend, but one that's relatively modest for a utility stock.

Then again, thanks to its smaller size, it has managed to deliver industry-leading share gains to shareholders in the last five years -- and well ahead of most peers. With a steady stream of capital investments planned, and a more manageable debt profile after a recent financing, NiSource may deserve a closer look than you've given it.

Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool recommends Dominion Energy, Inc. The Motley Fool has a disclosure policy.