The capital-intensive nature of utility companies makes them heavily dependent on debt to run and grow their businesses. As seen below, Duke has less than $1 billion in cash on its balance sheet compared to nearly $40 billion of debt.
However, the company’s excellent business stability has enabled Duke Energy to maintain an A- credit rating with Standard & Poor’s. While the company’s free cash flow will remain restricted the next few years to fund its major growth investments, forcing it to lean even more on debt markets, we still view Duke as a healthy business as well.
Source: Simply Safe Dividends
Overall, the stability of Duke Energy’s earnings and non-discretionary nature of its services significantly boost the safety of its dividend payment despite its levered balance sheet and relatively high payout ratio.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
While regulations generally protect utility company’s earnings and market share, they also limit growth opportunities. As a result, most utility businesses have below-average dividend growth rates, and Duke Energy is no exception.
The company’s Dividend Growth Score is 20, which suggests that its dividend growth potential is lower than 80% of all other dividend-paying stocks in the market. However, its dividend has been reliable. Duke Energy has made quarterly dividend payments since the 1920s and will raise its dividend for its ninth consecutive year in 2016, keeping it a far distance from joining the dividend aristocrats list but rewarding shareholders nicely.
For most of the last 10 years, Duke Energy grew its dividend by an annualized rate of about 2%. However, management expects to double the dividend’s growth rate to 4% per year to better reflect an improvement in Duke’s lower risk business mix and core earnings growth rate of 4-6% per year.
Source: Duke Energy Investor Presentation
Higher dividend growth will cause Duke Energy’s earnings payout ratio to increase from its 65-70% target to closer to 75% in the near-term as its growth investments continue, but the payout ratio is expected to turn down over time.
Valuation
DUK’s stock trades at 16.8x forward earnings estimates and has a dividend yield of 4.2%, which is slightly below its five-year average dividend yield of 4.4%.
Since 2009, the company has met its long-term annual adjusted diluted earnings per share growth objective of 4-6%. Assuming Duke Energy’s growth projects continue helping its core businesses realize 5% annual earnings growth over the coming years, the stock’s total return potential appears to be about 9% per year.
Considering the stability of Duke Energy’s earnings, which are largely composed of regulated utility operations, we think the stock is reasonably valued today but not a bargain.
Conclusion
For investors seeking exposure to utility stocks and safe dividend income, Duke Energy Corp (NYSE:DUK) appears to be a reasonably-priced blue chip dividend stock to consider. Almost all of the company’s business mix consists of regulated operations, which provide predictable earnings with low volatility. Most of the regions Duke Energy plays in are also characterized by favorable demographics and historically supportive regulatory bodies.
While there is some long-term risk resulting from lower electricity usage trends, the rise of clean renewables, and the company’s major growth investments, we think Duke Energy will remain an appealing income investment for many years to come.
Disclosure: None
