Please ensure Javascript is enabled for purposes of website accessibility

Despite the Big Rally, These 2 Utility Stocks Are Still Worth Owning

By Reuben Gregg Brewer – Apr 27, 2019 at 5:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Up more than the S&P 500 over the past year, these two high-yield utilities still offer plenty of value for income investors.

The S&P 500 index is up roughly 10% over the past year or so, but giant U.S. utilities Southern Company (SO -1.04%) and Dominion Energy (D -1.06%) are up more than 14%. That outperformance might come as a surprise to some, considering that these diversified utilities are known for their big yields and boring government-regulated businesses. Despite the rally, however, both are still interesting options for income investors looking to add reliable dividend payers to the mix.

Getting the project back on track

Southern Company offers investors a 4.6% yield despite the big rally during the past year. That's toward the high end of the utility peer group, but for a very good reason. Southern has had problems getting a big capital investment past the finish line.

A nuclear power plant in the distance with flowers in the foreground.

Image source: Getty Images

The company started work on the Vogtle nuclear-power project in 2012. Building two new nuclear reactors at the site, which already has two operating units, has not gone particularly well. There were cost overruns and delays, and then contractor Westinghouse declared bankruptcy. That last one put the entire project at risk, but Southern stepped in and took responsibility for overseeing construction. More recently, Southern's partners balked at a price-tag increase, forcing the utility to also take on the financial risk of rising costs. 

It would be premature to call this a disastrous investment, but so far it looks pretty bad. However, things have been getting better. For one, the new nuclear technology behind the Vogtle project has finally been stress-tested, as Chinese units using the same reactors are now up and running. Southern has been able to learn from those start-ups and streamline its plans. And, as of the last company update, Southern has been exceeding its productivity targets. That suggests that it is actually on track to complete the plants in late 2021 and late 2022, as currently scheduled. 

There's still a lot of work to be done, but at this point the future is starting to look a lot brighter. But Southern's capital spending is high right now and it has been forced to increase its leverage. Long-term debt increased from roughly $18.7 billion in 2012 to about $40.7 billion at the end of 2018. That puts long-term debt at roughly 60% of the capital structure, a high but not unreasonable figure (it was roughly 50% in 2012). The payout ratio in 2018, meanwhile, was nearly 100%, even though management has committed to continue increasing its dividend modestly each year.   

SO Dividend Yield (TTM) Chart

SO Dividend Yield (TTM) data by YCharts

All in all, there are still reasons to worry about Southern's big dig. But with the project nearing completion, and currently progressing well, investors willing to keep an eye on this giant U.S. utility can collect a fat yield, noting that, once completed, Southern can refocus on deleveraging because its capital investment needs will decline materially. And that, in turn, should improve the dividend coverage ratio.

That didn't work as planned

Dominion Energy is offering a yield of 4.4%, even after the stock advance it's seen. Like Southern, the yield is toward the high end of the utility group. Although Dominion doesn't have a huge construction project to worry about, it has been working on notable projects -- including a now-complete liquefied natural gas export facility. It's also working on a major pipeline project to supply gas to the Northeast. But nothing Dominion has in the works is as contentious as Southern's Vogtle project. The problem for Dominion has been funding all of its plans.

Originally, Dominion created a controlled limited partnership (Dominion Energy Midstream Partners) to use as a funding vehicle. Dominion was going to sell (or drop down) midstream assets it owned and use the cash for growth spending. A regulatory change threw that plan out the window. Dominion was forced to rethink its financing needs, opting to buy its controlled partnership and make greater use of debt. During the past decade, long-term debt at Dominion has roughly doubled, going from $15.5 billion in 2009 to $31 billion in 2018. Debt is roughly 60% of the capital structure today -- again high, but not outlandish. 

SO Chart

SO data by YCharts

The thing is, Dominion hasn't simply taken on more debt to fund itself. It's also been working to sell assets so that debt doesn't get out of hand. In fact, asset sales have been completed ahead of schedule, improving the outlook even as the utility makes moves to cement its industry position (including buying troubled peer SCANA). Dominion's payout ratio, meanwhile, was around 70% in 2018, down from nearly 90% in 2017, so things really are starting to look better. Although you shouldn't expect massive dividend growth here -- as the company continues to work on shoring up its financial foundation -- with such a high yield it's still worth a close look for income investors. 

A little more work

There's no question that Dominion and Southern require a little more attention than other stocks, as both are working through a period marked by high leverage. Still, both offer industry-leading dividend yields and appear to be making progress in alleviating their respective troubles. Dominion is further along in its efforts than Southern, which still has a couple of years of heavy spending ahead of it. But both are worth a close look for income investors that can handle near-term uncertainty in exchange for above-market yields.

Reuben Gregg Brewer owns shares of Dominion Energy, Inc and Southern Company. The Motley Fool recommends Dominion Energy, Inc. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Dominion Energy, Inc Stock Quote
Dominion Energy, Inc
$60.88 (-1.06%) $0.65
Southern Company Stock Quote
Southern Company
$66.22 (-1.04%) $0.69

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

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/28/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.