When interest rates rise, dividend stocks can sometimes fall because investors switch to lower-risk income options, like CDs. But there's another issue facing utilities, given that these capital-intensive businesses make heavy use of debt financing. Thus, rising costs are a second headwind for the sector.
Over the long term, however, regulated utilities should adjust and continue to provide reliable income streams to shareholders. If you think in decades, you'll want to consider adding NextEra Energy (NEE -1.36%), Black Hills Corporation (BKH -0.63%), and Dominion Energy (D -1.02%) to your portfolio in March.
1. NextEra Energy is a growth and income gem
NextEra Energy's 3.7% dividend yield is modest compared to the other two utilities on this list. In fact, it is only 10 basis points above the average of the broader utility sector. But the yield is near a 10-year high for NextEra Energy, suggesting the stock is cheap today.
However, the real linchpin in the story is the average annualized dividend growth of around 10% over the past decade, extremely high by utility standards. Management expects to raise the dividend by that much again in 2024.
The story here comes in two parts. First, NextEra Energy owns the largest utility in Florida, which is a state with a growing population. That's the solid foundation. On top of that, NextEra Energy owns one of the world's largest portfolios of solar and wind power assets. This is a growth business, with management hoping to double its clean energy capacity by 2026.
The combination of these two businesses is expected to produce earnings growth of between 6% and 8% a year through 2026. Even if dividend growth only tracks along with earnings growth after 2024, that's still a great outcome for a growth- and income-oriented utility. Investors should look at this stock, which has increased its dividend annually for nearly three decades and is still on sale.
2. Black Hills is a slow and boring tortoise
Compared to NextEra Energy, Black Hills Corporation is a bit of a snooze. The company is relatively small in the utility sector, with a modest market cap of just $3.5 billion (NextEra's market cap is $110 billion, for reference). It serves 1.3 million natural gas and electricity customers across parts of eight Western and Mid-Western states. Black Hills is nothing more than a small, traditional, regulated utility.
However, the regions it serves are growing at nearly 3 times the rate of the U.S. population, which is good for long-term growth. That backing has allowed Black Hills to achieve Dividend King status. Sure, the dividend has grown at just 5% a year on average over the past decade.
But that's more than enough to outpace the historical inflation growth rate and is a pretty solid number in the utility space. And while rising interest rates will be a short-term headwind, it seems highly unlikely that this fact alone will upend Black Hills' slow and steady growth over the long term. Conservative income investors will want to do a deep dive while the dividend yield is near decade highs at 5%.
3. Dominion is changing things up
The last utility here will be an acquired taste, largely attractive to investors interested in turnaround stories. The dividend yield is just shy of 6%. The problem is that the dividend will likely be static for at least another few years as the utility revamps its asset portfolio. It is also attempting to reduce leverage and bring its payout ratio more in line with its utility peers. But if you can stomach a stock with a dividend that isn't going to grow for a bit, Dominion is well into its turnaround plan.
The first step was a major review of the business, which has now been completed. It has already inked deals to sell a number of assets, with the proceeds from the sales earmarked for debt reduction. These sales will take place over the next year or so. After that is complete, management expects earnings growth of between 6% and 8% annually through 2029.
Assuming management can execute that goal, Wall Street will likely get increasingly upbeat on the future. And the payout ratio will slowly decline into the company's target range in the mid-60% space. When that happens, dividend growth will return. Although that could take between three and five years, the 6% yield is material enough to make it a worthwhile wait for turnaround investors.
Options for dividend investors
The utility sector is filled with unique stories, as are most sectors. If you like dividend growth stocks, you'll appreciate NextEra Energy's tale. If you like slow and conservative investments, Black Hills will be the story for you. And if you are a bit more adventurous, high-yield Dominion Energy will probably be of interest.
