Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low, it's not even worth the paper your dividend check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today, and one day each week for the rest of the year, we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say that these stocks don't share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. Check out last week's selection.
This week, we'll turn our attention to the electric utility sector, home of many great dividends, and take a closer look at why Entergy (ETR -0.34%) could be a great income play you can buy right now.
Utilities' short circuit
The great thing about utility stocks from an income perspective is that energy is a basic need. In many cases, whether the economy is booming or in a recession, energy demand will remain relatively constant. But the utility sector has also greatly underperformed the overall market since the recession because of a number of factors, including the proliferation of cheap natural gas and the high ongoing expenses of operating nuclear facilities.
Exelon (EXC -0.19%), the nation's largest nuclear power operator in the U.S., is a good example of a utility that's struggled to compete. Despite being a cleaner form of energy than coal, nuclear power, without any subsidies, will continue to run consistently higher in terms of costs than nearly every other fuel source. These higher costs have actually pre-empted some utilities to close their nuclear facilities even earlier than expected. Entergy, for instance, recently took a $240 million charge in the second-quarter to put a nuclear facility in Vermont into early retirement.
Another issue has been the declining price of natural gas, which has made more traditional forms of electric-generation like coal more costly. Duke Energy (DUK -0.79%) recently announced that it, too, will be closing five of its Indiana-based coal-fired plants early because the costs to maintain them was simply too high to justify keeping them open. FirstEnergy (FE 0.34%) made a similar announcement last year by retiring six of its coal-powered plants. FirstEnergy blamed environmental regulations for the closure of its six facilities, but I have to think that the higher costs of coal relative to natural gas had to play a role as well.
The Entergy advantage
The first thing that Entergy has going for it, that I touched on earlier, is that utilities offer an abundant but necessity resource: energy. Energy demand is relatively consistent regardless of the economic environment, which often translates into steady earnings and cash flow generation.
The past quarter for Entergy was a little bit of an anomaly, because it was given such a dramatic tax break in 2012 because of storm cost financings in Louisiana. With those tax breaks now removed, it looks as if Entergy had a miserable second quarter, reporting just a $0.92-per-share profit versus last year's $2.06. However, this couldn't be further from the truth. Electric revenue actually rose by nearly 13% year over year with a modest increase in decommissioning and power costs chipping away at its revenue increase. In other words, it's business as usual for Entergy!
Entergy is also doing what it can to control its costs. The thought of taking hefty charges to retire a nuclear plant early might not make a lot of sense until you understand that it saves money through job cuts as well. Through a companywide human capital management overhaul as Entergy likes to call it, or a restructuring as the rest of us would refer to it, the company should be able to save $200 million to $250 million on annual basis by 2016 -- adding potentially $1 to EPS just on cost savings alone!
Energy efficiency also offers a way for Entergy to stand out from its peers. The company, between 2002 and 2011, invested $79 million in energy efficiency programs that delivered 185 MW of savings.
Show me the money, Entergy
Entergy's performance since the recession hasn't been anything to write home about, but its plan to build shareholder value is certainly worth taking note of. One of the ways that Entergy hopes to boost shareholder value is through share repurchases. Although share repurchases don't put money directly into investors' pockets, they do make a company appear cheaper on a P/E basis by reducing the number of shares outstanding. Since 2003, Entergy has brought its outstanding share count down from 231 million to 178 million all while its book value has risen from $38.04 to $52.02 in the most recent quarter.
The big allure for Entergy, though, is its dividend. Although the company has failed to raise its dividend since 2010, you'll probably get no complaints from shareholders:
Based on Entergy's Friday closing price, shareholders are currently receiving a U.S. Treasury bond-thumping 5.3% annual yield! Since the beginning of 2003, Entergy's dividend has been increased just four times, but for a cumulative jump of 137%! Another way to look at it is this: since 2003, Entergy has paid out nearly $30 per share in cumulative dividends! Furthermore, with a payout ratio of just 67% based on this year's projected EPS, Entergy's dividend is both sustainable and likely to grow in the future as it's able to pass along price hikes to consumers.
Obviously, Entergy isn't perfect. It could certainly use a little alternative-energy pep in its step and would love to see a nuclear subsidy from the U.S. government. However, when push comes to shove there are fewer electric utilities valued as cheaply as Entergy. At its forward P/E of just 12 and less than four times free cash flow, investors are getting a utility with a basic-needs product that consistently produces profits and pays out better than 5% each year!