Duke Energy (NYSE:DUK) is one of the largest electric and natural gas utilities in the United States. But so far this year, its shares are up a modest 3% compared to the 14% gain in the Vanguard Utilities ETF. Why is Duke lagging behind the utility sector, and is that presenting investors with a buying opportunity?
Sizing things up
Duke has a market cap of nearly $65 billion, easily placing it among the largest energy stocks in the country. It offers regulated electric and natural gas services to 9.3 million customers, owns midstream energy assets, and operates a renewable power business that sells electricity to others under long-term contracts. It plays with industry giants like NextEra, Southern, and Dominion Energy.
The stock offers investors a fat 4.2% dividend yield, which is toward the high end of the utility peer group. It has increased its dividend for 13 consecutive years, if you include 2019. And Duke's adjusted diluted earnings payout ratio in 2019 is projected to be around 75%, which is right inside its targeted range of 65% to 75% for this metric.
Duke has plans to spend $37.5 billion between 2019 and 2023 on growth projects, with about 90% going toward regulated businesses. It believes these investments will allow it to win government approval for rate increases and lead to earnings growth of between 4% and 6% annually over the same span. Although it isn't currently providing dividend-growth guidance, it is committed to keeping its dividend streak alive.
So far, Duke sounds like a pretty swell investment opportunity for a conservative income investor. So why is it underperforming its peers?
Some negative news
For starters, Duke has a material debt load. It is an investment-grade utility, but its debt-to-equity ratio is higher than most of its closest peers'. In fact, it's about twice that of NextEra. It's higher even than Southern's, and that company is building two nuclear power plants that, while back on track today, are still way over the original budget. Worse, Duke is spending more money than it is bringing in through its operations, forcing it to bridge the gap with even more debt and equity sales. In short, its big spending plans will help growth over the long term, but today they are weighing on the balance sheet and crimping earnings a bit because of shareholder dilution.
Then there's the difference between adjusted earnings and earnings as defined by generally accepted accounting principles (GAAP). Looking at 2018, the GAAP earnings payout ratio was a worrying 97%. The company's adjusted earnings figure is a non-GAAP measure that pulls out one-time items. But those items are usually cherry-picked by management to make the company look better. So the dividend may not be quite as easy to cover as management would like you to think it is. And, as noted above, its cash flow isn't enough to fund the distribution and its capital spending plans, so the cash dividend payout ratio is negative. These are troubling signs that help explain why Duke isn't finding much love in the market.
That said, the company's price-to-earnings ratio is currently just a touch higher than its five-year average P/E. So, too, are its price-to-sales, price-to-book-value, and price-to-cash-flow ratios. That suggests that, if anything, Duke is about fairly priced right now, if not a little expensive. There's no particular reason to expect the utility's stock to move higher from here unless there's some notable positive news that improves investor sentiment. That's not particularly likely for this boring old utility.
Not a screaming buy
As a large and fairly well-run regulated utility, Duke should be able to continue investing in its future and paying its dividend. It will probably be able to keep increasing the disbursement in the low- to mid-single-digit range, as well. But it is not a great deal today from a valuation standpoint, particularly when you take into consideration the cost of its investment plans and heavy leverage. For income investors looking to maximize the income their portfolio generates, it may be worth a look because of its high yield. But there are other options in the utility space that would be just as attractive, if not more so.