The utility sector is generally one of the more boring segments of the broader energy industry, but that doesn't mean it is always uneventful. In fact, rising interest rates have resulted in Wall Street shunning utility stocks. While there are some good reasons for that, it has opened up an opportunity for long-term income investors to buy reliable dividend stocks like NextEra Energy (NEE -1.36%), Duke Energy (DUK -1.33%), and Black Hills Corporation (BKH -0.63%). Here's a look at each of these energy specialists.
A quick primer on an industry downturn
There's no way to hide the fact that utility stocks are in the dumps today. As the chart below clearly shows, the utility sector, using Vanguard Utilities ETF (VPU -1.14%) as a proxy, has been heading lower while the S&P 500 index has been moving higher. What's been going on? The big issue is that interest rates have been on the rise. That poses two problems for utility stocks.
First, other income options, like certificates of deposit (CDs), are more competitive with some stocks, like utilities, that are known for producing income. If you can get a 5% or so yield from a super-safe CD, why take on the risk of owning a similarly yielding stock? The opportunity for dividend growth is one (very good) reason, but sometimes investors are too short-term focused. As a result, money has shifted out of the utility sector.
Second, and probably more important to consider, is that utilities tend to be capital-intensive companies. That means debt is often a key part of the capital structure. Rising interest rates simply make it more expensive to do business. This will probably hurt near-term financial results throughout the sector. It makes some sense that investors are worried about that. However, these are largely regulated businesses. That means that the government has to approve capital spending plans and rate structures, balancing the need for profit against cost and reliability for customers. Higher rates will, eventually, be taken into consideration in that equation. So, over the long term, slow-and-steady growth is still the likely outcome.
In the end, then, the current industry malaise is probably a long-term opportunity for dividend investors.
Three solid options for dividend investors
NextEra Energy is going to be most attractive to dividend growth investors. Although it owns one of the largest regulated utility operations in the United States (Florida Power & Light), about 30% of its business is dedicated to a rapidly expanding renewable power business. That combination has resulted in annual dividend growth of around 10% on average over the past decade. Management currently believes it can increase the dividend at around that same rate through at least 2026.
That's a pretty astounding pace of dividend growth in the utility sector, which explains why NextEra Energy has long been afforded a premium valuation. But thanks to the current industry downturn, the yield is near a 10-year high at about 3.3%. While that's below the 3.5% industry average, it is still a great opportunity for dividend growth investors; the dividend has been raised annually for 29 consecutive years.
Duke Energy is a bit more conventional. While it is also one of the largest utility companies in the United States, it doesn't have a fast-growing clean energy business like NextEra Energy does. In fact, Duke recently agreed to sell the non-regulated clean energy business it did own. Effectively, it is doubling down on regulated assets, which will increasingly require clean energy investments to be made. But making those investments within the regulated framework will provide more consistent returns. The company has increased its dividend annually for 19 consecutive years and the dividend yield is toward the high end its range over the past decade at 4.3%. Note that the yield is notably above the industry average.
The last utility up is tiny Black Hills Corporation, which has a yield of just about 5%. Like the other two utilities here, that's toward the high end of the range over the past decade. Before moving on to the big reason to like Black Hills, it is worth highlighting just how small it is. This utility's market cap is $3.5 billion, which compares to $72 billion for Duke and a whopping $126 billion for NextEra. That's why it is all the more impressive to see that, of the three, Black Hills is the only one that happens to be a Dividend King, with 55 years' worth of annual dividend increases behind it. It is something of a hidden gem in the utility sector. Like Duke, it is a simple regulated utility, but if you appreciate dividend consistency, it wins hands-down.
There are good options in this out-of-favor industry
Wall Street is particularly downbeat on the utility sector today and that is creating long-term opportunity for dividend investors. You just have to be willing to go against the grain and buy when others are selling. However, if you take the time, you'll find that there are a lot of options in the sector, including dividend-growth stocks like NextEra, boring and reliable giants like Duke, and even Dividend Kings like Black Hills. If you like dividends, don't let this utility sell-off pass you buy without at least doing a deep dive into the space.
