Rising interest rates have put pressure on the utility sector, which generally competes for dollars with other income-oriented investments. Basically, when you can buy a certificate of deposit (CD) with a 5% or so yield, it gets harder to justify a utility stock with a similar or lower yield.
But the downturn in the utility sector could be a buying opportunity for dividend investors who think in decades, because of the opportunity for dividend growth, which you won't get from a CD. Here are three utilities you'll want to look at right now.
1. NextEra Energy has a unique portfolio
NextEra Energy (NEE -1.36%) owns one of the largest regulated utilities in the United States, Florida Power & Light. This business has long benefited from people moving to the Sunshine State, which increases customer growth, and fairly strong regulator relationships, which allow attractive rate and investment decisions. But the real story with NextEra Energy is its renewable power business, which is the company's growth engine.
Basically, the regulated utility provides the foundation, while renewable power allows higher levels of business expansion. It's an attractive mix, considering that NextEra is one of the largest producers of solar and wind power in the world at this point. Not only has this fast-growing business segment helped the utility to increase its dividend annually for 29 consecutive years, but the average annual increase over the past decade was a huge 10%! That's massive for a utility.
To be fair, higher interest rates will make it more expensive to fund the company's capital investment plans. But given the strong history here, there's no reason to doubt management's recent statements that it believes earnings growth will fall between 6% and 8% a year, with near-term dividend growth of roughly 10%. The one downside is that the yield is a bit low by utility industry standards at 3.7%. That yield, however, happens to be fairly attractive compared to the company's own historical yield range.
2. Black Hills is a prime example of a tortoise
Next up is relatively small Black Hills Corporation (BKH -0.63%), which is a far more traditional electric and natural gas utility. It serves 1.3 million utility customers across Arkansas, Colorado, Iowa, Kansas, Montana, Nebraska, South Dakota, and Wyoming. There's nothing exciting about the company, though it does boast higher customer growth rates than the average population growth for the United States. That's a good sign and suggests that the business remains on solid ground.
What is really appealing here, however, is the commitment to the dividend, which has been increased annually for more than five decades. That makes Black Hills a highly elite Dividend King. That said, the growth rate has averaged around 5% over the trailing one-, three-, five-, and 10-year periods. It seems reasonable to expect mid-single-digit dividend growth and little more.
Effectively, that makes it a reliable and slow-growing utility. While that may not appeal to everyone, Black Hills could be a solid cornerstone investment for investors who are looking to build a reliable passive income stream. It yields around 5.1% today, which is fairly attractive, historically speaking.
3. Southern is ready to pick up the pace
Getting back to industry giants, we round out this trio with The Southern Company (SO -1.56%). This utility operates in a number of Southern U.S. states, as its name implies, but the story here is dominated by a huge capital investment project. The two new nuclear power plants (known collectively as the Vogtle project) it has been building are late and over budget. But the company is on the verge of completing both. That is expected to increase its cash flow from operations by around $700 million.
That's a game changer. While construction was ongoing, Southern's dividend growth was roughly enough to keep up with the historical growth rate of inflation. But once it is done with the nuclear build, dividend growth is likely to pick up into the mid-single digits, to better align with earnings growth. Investors will likely rethink the valuation of the company when that happens, probably in 2025 or so.
The yield today is 4.3%. And the opportunity for higher dividend growth from a company that has increased or held the dividend steady for over 75 years makes this an attractive growth and income option.
Hold your nose and jump in
There's no doubt that Wall Street is downbeat on the utility sector today. Higher interest rates not only open up other "safe" places for yield, like CDs, but will also make growth spending more expensive. However, NextEra, Black Hills, and Southern all have long and successful operating histories -- they have muddled through difficult times before while continuing to reward investors with reliable dividend payments. One of them is likely to find a place in your passive income portfolio if you can think like a contrarian today.
