Utility stocks like Duke Energy (DUK -3.19%) are seen as safe-haven investments. They are favored by conservative investors, the so-called widows and orphans that want reliable dividends. But is Duke -- with its 4.3% yield -- a good buy today? Here's a quick look at some key facts to help you decide.
1. A reliable business
Duke sells electricity to 7.5 million customers in six states and natural gas to 1.6 million customers in five states. It also has a small renewable power business that sells clean energy to other companies under long-term contracts. The electric business contributed 85% of the company's earnings in 2019, with the natural gas chipping in 9%. Renewable power operations made up the rest. Virtually all of its business is either regulated by the government in some way or tied to long-term contracts.
Essentially, Duke is just a boring utility stock. That, however, is a good thing in many ways. For one thing, although it has to get its rates approved by regulators, it has a monopoly in most of the regions it serves, providing a consistency to revenue and earnings. Electricity and natural gas are basically necessities for a modern society. Duke's capital spending plans are intended to ensure reliability and an adequate supply of energy in the future, which are key things that regulators are looking to achieve. So its spending and growth plans are long-term in nature, and fairly consistent over time. The ups and downs of Wall Street aren't the main driving force. All in all, Duke does fit the widows and orphans mold.
2. A reliable dividend
Duke's dividend yield is roughly 4.3%. That is notably higher than the 2% or so yield offered by the S&P 500 Index today, and a full percentage point above the utility average of about 3.3%, using Vanguard Utility Index ETF as a proxy. That dividend, meanwhile, has been increased annually for 15 consecutive years. As you might expect, however, the average annualized increase was modest, at around 3% over the past 10 years. That's roughly enough to keep up with inflation over time, and thus at least maintain the buying power of the dividend payment, if not grow it a little bit. Its payout ratio is targeted to be in the 65% to 75% range, which is about where it is today. That's not out of line with utility peers, and while it may at first seem high, the regulated nature of the business and reliable sales can support it.
The slow and steady nature of Duke's dividend is one of the reasons for the relatively high yield. There are other options in the space, such as NextEra Energy (NEE -1.27%), that have materially higher dividend growth rates. For reference, NextEra's dividend has been increased annually for 26 years, with an annualized growth rate of 10% over the past decade. However, NextEra's yield is a far more modest 2.4%, and it almost always trades at a premium to peers. In short, if you are looking for rapid dividend growth, there are better options. However, for investors focusing on current income, Duke is a solid choice.
3. An OK financial foundation
So far Duke looks pretty good, but there is one area that investors need to watch a bit more closely: the balance sheet. Duke's financial debt to equity ratio of roughly 0.85 times is higher than those of its closest peers. The financial debt to EBITDA ratio of 5.2 times is also toward the high end of similarly sized U.S. utilities. And while Duke covers its interest expenses by a solid 2.9 times, there are definitely others in the industry with firmer financial footings. All in all, this isn't a reason to avoid Duke per se, but it is worth noting that Duke makes material use of leverage, a fact that should be monitored regularly.
4. A reliable growth outlook
The importance of the balance sheet comes into play when you look at Duke's capital spending plans. Between 2020 and 2024 the utility plans to invest around $56 billion in its operations. That's up roughly 12% over its previous five-year plan. Most of that will go to its regulated businesses, and is supported by regions with growing populations. The company expects the spending to drive 4% to 6% annualized earnings growth through 2024. The dividend should tag along for the ride, increasing in line with historical trends.
That's all well and good, and there's no reason to expect Duke will fall short of its goals. However, $56 billion, or around $5 billion a year, is a lot of money. With such a material payout ratio, Duke will likely be relying on debt markets to fund that level of spending. The balance sheet is, thus, integrally tied in with Duke's growth plans.
5. What about COVID-19?
Another issue to consider today is the coronavirus. In an effort to slow the spread of COVID-19, businesses around the country have been shut down, and people are being asked to stay at home. In fact, the efforts to combat COVID-19 are likely to push the United States into a recession. Few companies will avoid taking a financial hit from what is going on here.
Notably, commercial and industrial customers make up about 50% of Duke's electricity business, so it could see a larger hit than some of its peers. However, the necessity of what it sells means its business should bounce back once government-mandated restrictions are lifted.
That said, utilities generally keep only modest amounts of cash on hand. If the shutdowns from COVID-19 drag on for an extended period (think a year or so) or it materially alters demand dynamics, Duke and its peers could be in bigger trouble. At this point, however, such a dire outcome doesn't appear likely based on historical experience.
A solid pick
All in all, Duke Energy is a reliable, if not boring, utility stock. It isn't perfect, as highlighted by its balance sheet, but there doesn't appear to be anything material that should concern investors today. That includes COVID-19, which will likely crimp Duke's earnings, but not derail its business over the long term. The yield, meanwhile, is generous relative to those of peers.
If you are looking to maximize the dividend income your portfolio generates today, Duke is definitely worth a closer look.