Duke Energy (DUK -1.33%) just made a big decision: It has agreed to sell its business focused on developing clean energy assets. But don't think this means an end to clean energy as it relates to Duke. Far from it! In reality, this giant U.S. utility will continue to invest in clean energy, but now it will have regulator-guaranteed returns on those investments. If you like boring dividend stocks, this move will probably make Duke more attractive.
Core and explore
Duke Energy is, for the most part, a regulated utility. That means it gets a monopoly in the regions where it operates, but it also agrees to be subject to government oversight. Regulators have to approve the company's capital-spending plans and its rate increases. Generally, regulators are pretty reasonable, but they are rarely overly generous. So Duke Energy's growth has been slow and steady over time.
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A big portion of an investor's return will come from the stock's 4.3% dividend yield. This is notably higher than the 3.3% yield on offer from the average utility, using Vanguard Utilities Index ETF as a proxy. But, given the regulated backdrop, that dividend is well supported by the company's business of selling power. Growth will be modest -- think in the single digits -- creating a yield-plus-earnings-growth total that is in the high-single digits. If you are looking for reliable income, that's not a bad balance.
That said, historically, Duke has tried to layer on higher-growth investments that aren't subject to government regulation. This is how it built a portfolio of contract-driven clean energy assets. Although not regulated, long-term power-purchase agreements make such clean energy investments fairly reliable cash generators. When few were building large-scale clean energy projects, Duke had an edge in this business. Now that competition has increased, putting pressure on the returns from those investments, Duke no longer sees this type of investment as worthwhile when all risks and rewards are factored in.
Getting out to get better
This is why Duke just agreed to sell its contract renewable-power operations to Brookfield Renewable (BEP 0.19%) (BEPC 0.09%) for a total cost of $2.8 billion. Duke will net roughly $1.1 billion from the sale, which includes the assumption of debt, and intends to use the proceeds to strengthen its balance sheet. The transaction will pull roughly 3.4 gigawatts of clean energy from Duke's portfolio.
Duke has taken some write-offs as it moved toward this sale, so the investments it made don't appear to have lived up to expectations. The increasing competition in the clean energy space probably had a lot to do with that. But the bigger takeaway here is what this move changes about the company's future.
For starters, management is still calling for long-term earnings growth of between 5% and 7% a year, on average, over the near term. Dividend growth has averaged in the low-single digits over the past decade, so it's reasonable to expect a similar rate in the future with a high end, perhaps, in the mid-single digits. Add in the roughly 4% dividend yield, and you still get to a respectable total return for a utility in the high-single digits.
But, instead of having to rely on a competitive market to support the growth of its renewables business, Duke is going to be building out utility-scale clean energy assets for its owned utilities. That means more reliable returns on its investment, since the returns are regulated by the government. Moreover, regulators generally view capital spending on clean energy favorably, which should increase the chances of positive regulatory outcomes.
More boring, more better
All told, Duke appears to be taking some lumps as it exits a business that hasn't been as positive as hoped. But the move will allow the utility to focus on similar assets under the regulated framework. So the clean energy growth that was related to the contract-renewable portfolio isn't exactly gone; it has just changed shape. That will make Duke an even more reliable business than it was before. If you are looking for a reliable high-yield utility stock, Duke should probably be on your short list today.
