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This 5.8% Yield Is Worth the Risk

By Reuben Gregg Brewer – Aug 14, 2018 at 6:02AM

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PPL's yield is huge in the utility space -- here's why you might want to consider the stock anyway.

PPL Corporation (PPL -0.34%) has a dividend yield of 5.8%, relatively high when you compare it to fellow utility companies like Southern Company (SO 0.21%) and Duke Energy (DUK -0.39%), which sport yields of 5% and 4.7%, respectively. That higher yield should make you question PPL as an investment...but once you find out what's going on here, you'll probably be pleased to jump aboard this high-yielding utility.

A differentiated model

PPL is somewhat unique in the utility space in that it operates in the both the United States and the United Kingdom. Pennsylvania makes up around 26% of its rate base, Kentucky 36%, and the U.K. 38%. In a nutshell, the material foreign exposure is one of two big reasons why investors are concerned about PPL's business, demanding a yield premium over peers.   

A man standing in front of power transmission equipment

Image source: Getty Images.

Worrying about the U.K. business is not an unreasonable thing. The utility business in the United Kingdom is something that not many U.S. investors are familiar with, which increases uncertainty. And having foreign exposure opens the company up to currency fluctuations. For example, the company's first-quarter earnings of $0.65 a share included a $0.09 hit because of exchange rates.   

Is the concern about the foreign segment enough to justify the discount here? I've already noted the higher yield, but PPL's forward PE ratio is a tiny 12.4 times compared to around 20 for Duke and 42 for Southern. It looks really cheap today if that's the only "problem." Which brings up the second big issue, coal.

PPL's U.S. utilities are heavily reliant on the dirty fuel today, which makes up roughly 80% of its power fleet. That doesn't sound very good. But to figure out if the mixture of a heavy reliance on coal and exposure to the U.K. is really all that bad, you need to think outside the box just a little. 

A solid core

One of the first things to highlight with PPL, or any company with a foreign arm, is that currency changes tend to wash out over time. Although the currency issue has been hampering results lately, the utility's 2016 results included a $0.34 per-share benefit from currency changes. In the end, some years will benefit and some years take a hit; you should look at earnings from ongoing operations (which pull out currency impacts) if you want to get a better idea of what's going on.

PPL's earnings from ongoing operations were up 19% in the first quarter on strength in its U.S. business, which more than offset weakness in the U.K. Currency is an issue, but one you should take with a grain of salt because the underlying business may still be doing just fine.   

When looking at the company's ongoing operations, meanwhile, you can't ignore the utility's growth projections. It believes that its investment plans will support 5% to 6% annual rate base growth through 2020. That includes rate base growth of roughly 20% in Pennsylvania, 11% in Kentucky, and around 10.5% in the United Kingdom between 2017 and 2020. Yes, the U.K. is the weakest link, but it is hardly a negative contributor.     

Now step back. Capital spending is what drives rate increases at regulated utilities. With so much coal capacity, PPL has plenty of leeway to justify its investment plans between today and 2050, when it hopes to have coal down to just 10% of its U.S. fleet. Having notable coal exposure looks like a negative, but as far as rate cases go it's kind of a long-term positives since regulators are highly likely to approve rate hikes that involve shutting down coal plants.     

While we're looking at things from a different angle, the U.K. arm actually offers diversification that few of the utility's U.S.-focused competitors have. That could become increasingly important as the global energy market continues to change. On that front, you should note that France's Total S.A., an international oil company, recently inked a deal to buy a European utility as it looks to continue its move beyond the oil business. If consolidation like that is a harbinger of things to come, PPL's international exposure could be seen as a strategic advantage.

PPL Financial Debt to Equity (Quarterly) Chart

PPL Financial Debt to Equity (Quarterly) data by YCharts

Then there's the fact that PPL has increased its dividend annually for 17 consecutive years. That's three years more than Duke and just a single year less than Southern. So while the yield is high, it's not like PPL has been letting its dividend-focused shareholders down. The growth rate over the past decade has been around 3.3%, about in line with the historic rate of inflation growth and enough to protect investors' buying power. The last two increases, meanwhile, were roughly 4%, closer to the projected 5% to 6% earnings growth the company expects each year through 2020. Leverage metrics, meanwhile, aren't out of line, so there's no reason to think debt troubles will become an issue.   

A little bit of worthwhile work

If you are seeking to maximize your current income, then PPL is a utility that should be on your radar screen. It requires more effort to understand the business because of the exposure to the United Kingdom and its current reliance on coal, but the relatively cheap valuation and high yield seem like they are well worth the effort. If you are looking for a high-yield utility, do yourself a favor and perform a deep dive on 5.8% yielding PPL -- the top-level concerns don't seem to be as big a deal once you take the time to look a little deeper.

Reuben Gregg Brewer owns shares of Southern Company. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Stocks Mentioned

PPL Stock Quote
$29.08 (-0.34%) $0.10
Southern Stock Quote
$67.48 (0.21%) $0.14
Duke Energy Stock Quote
Duke Energy
$99.13 (-0.39%) $0.39

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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