The prospect of the Federal Reserve winding down its monthly bond purchases, known as "tapering," has served as a major headwind for utilities. Investors became increasingly concerned that higher interest rates would mean drastically higher interest expenses for utilities, which heavily utilize debt as part of their capital structures.
While it's true that higher interest rates would indeed result in greater financing costs for utilities, a dose of perspective seems necessary. Interest rates have been much higher for most of the past several decades, and yet, utilities survived. Even with higher debt burdens, they still did what great utilities do best: produce stable cash flows, and reward shareholders with consistent dividend payments.
Therefore, despite the volatility utilities including Duke Energy (DUK 0.60%), Dominion Resources (D +0.10%), and PPL (PPL +0.55%) have seen in their stock prices, their underlying businesses continue to be stable. That's why, even in an environment of rising interest rates, investors who desire strong income should still consider great utilities.
Rate increases and favorable regulations mean secure profits
Taper or not, Duke Energy maintains a diverse geographic footprint, as well as already-secured rate increases that will provide a great deal of operating certainty in the years ahead. Although Duke's biggest geographic segment, the Carolinas, accounts for slightly more than half of its customer base, its remaining customers are evenly spread in Florida and across the Midwest.
Moreover, the regulatory environment in its biggest segment remains favorable. Regulatory approvals in the Carolinas will result in more than a 10% return on equity, and the company stated approved settlement agreements will provide approximately $535 million in annual revenue increases in the Carolinas.
These factors, when combined, are what compel Duke Energy to anticipate generating between 4% and 6% growth in adjusted earnings per share through 2015.
In that same vein, Dominion Resources is a well-run utility that has a great-looking future, even if we're at the onset of higher interest rates. Dominion's second quarter was a challenging one, evident by the fact that operating earnings fell short of the midpoint of the expected range previously guided by management. That being said, Dominion's operating EPS still rose 5% year over year, and management upheld its view that the company would see growth on a full-year basis.
Dominion still expects at least 5% EPS growth this year, and fortunately, the catalysts are there for it to realize its goal. First, Dominion is finally benefiting from growth projects related to prior investments in its gas transmission business. In the second quarter, the company's gas transmission margin expanded, providing a $30 million boost to the bottom line (and an extra $0.05 on an EPS basis).
Furthermore, Dominion expects to reap further rewards from its gas transmissions business, in addition to favorable rate increases. The company specifically cites higher rate adjustment clause revenue and higher projected revenue, related to its gas transmission growth projects, as positive factors in its third-quarter and full-year 2013 guidance.
Meanwhile, PPL has a very stable future ahead of it, which should be a profitable one for the company and its investors. 85% of PPL's 2013 earnings per share comes from regulated businesses, and going forward, PPL will benefit from fairly generous rate increases. PPL will be able to realize roughly 8% compound annual growth in rates through 2017, and the company was recently awarded more than 10% ROE in its major U.S. markets, Kentucky and Pennsylvania.
Don't throw a taper tantrum
Because of generous rate increases and stable future returns, income investors who love to receive those quarterly dividends don't need to obsess over the Federal Reserve and whether it will continue its aggressive stimulus. Well-run utilities such as these will continue to pass on rate increases, and due to their consistent businesses, should generate sufficient returns to help soften the blow of rising interest rates.
As a result, Duke Energy, Dominion Resources, and PPL will continue to grow, and the strong dividend payments their investors count on, should keep rolling in for many years.
