Duke Energy Isn't Just for Widows and Orphans
Utility stocks are often seen as appropriate only for conservative investors, the so-called "widows and orphans" investors. While utility stocks are often seen as approrpirate for those who can't afford to lose money in the market, these names can also provide attractive total returns.
While utility stocks may not have the appeal of a high-growth stock, they can offer solid double-digit returns when bought at the right price.
One utility stock that appears to be priced right is Duke Energy Corp. (NYSE:DUK). The stock has lost almost 10% so far in 2020, but this could mean a good opportunity to pick up a solid company on the cheap.
Company background and recent news
Duke is one of the largest regulated utility companies in the country. The company provides electricity to 7.6 million customers in North Carolina, Florida, Indiana, South Carolina, Ohio and Kentucky. Duke also provides gas to 1.6 million customers in Ohio, Kentucky, North Carolina, South Carolina and Tennessee. Duke generated revenue of $25 billion last year and trades with a market capitalization of $61 billion.
In early July, Duke, along with partner Dominion Energy (NYSE:D), called off plans to build the Atlantic Coast Pipeline as litigation and cost overruns had driven up the price to $8 billion. The expectation for costs was between $4.5 billon to $5 billion. The project wasn't expected to be completed until 2022.
Due to the cancelation of the ACP, Duke will take a non-cash pretax charge of $2 billion to $2.5 billion. Much of this charge was taken in the most recently completed quarter. Duke had expected the ACP to add as much as 35 cents per share to 2021 earnings.
Duke maintains its five-year $56 billion capital plan despite the removal of ACP. The planned $2 billion investment in the project will instead be shifted toward additional solar investments in Florida, grid modernization and gas distribution programs. Approximately 95% of the capital plan is dedicated to regulated electric and gas projects.
The company reported earnings results for the second quarter on Aug. 10. Revenue declined 7.7% to $5.4 billion, which also missed consensus estimates by $435 million. The company took a $1.63 billion charge related to the cancelled project, which resulted in a GAAP earnings loss of $1.13 per share. Excluding this charge, earnings per share decreased 4 cents, or 3.6%, to $1.08. This was 3 cents higher than expected.
As with many companies, Covid-19 had an impact on results. Residential electric volumes were strong, up 5% as customers spent more time than usual at home. On the other hand, electric volumes declined 13% for commercial customers and 15% for industrial customers. In total, electric volumes were down 6%, but ahead of Duke's previous guidance of down 9%. The company said on the conference call that nearly three-quarters of large commercial and industrial customers that were shut down in the second quarter are now resuming operations.
The number of electric customers has increased 1.7% year to date, led by 1.8% growth in the Carolinas. Gas customers has grown by 1.5% so far this year, with Piedmont Natural Gas supplying the bulk of this increase.
Duke expects the coronavirus pandemic will cause electrical volumes to decrease by 4% this year. Total retail volumes are seen as falling 3% to 5%. This is due to an expected drop of 7% to 10% in industrial volumes and a 6% to 9% decrease in commercial volumes. Offsetting this slightly will be a 2% to 4% increase in residential volumes. This will result in a headwind of an estimated 25 cents to 35 cents to earnings per share for the year.
The company is targeting a cost savings program of $350 million to $450 million in 2020. The company has achieved savings of $170 million through the end of the second quarter. The positive impact from these initiatives should make up for the impact from Covid-19.
Duke updated its forecast for 2020. The company maintains its expected adjusted earnings per share of $5.05 to $5.45 for the year, but now guides toward the low end of this range.
Dividend and valuation analysis
Following a 2.1% increase for the Sept. 16 payment, Duke has now raised its dividend for the past 16 years.
The company has raised its dividend by an average of:
3.7% per year over the past three years.
3.5% per year over the past five years.
2.9% per year over the past 10 years.
The most recent increase is below any of the above averages, but that is due to the company targeting a payout ratio in the 65% to 75% range. The new annualized dividend is $3.86, which would result in a payout ratio of 76% based on the low end of Duke's adjusted earnings per share guidance for the year. The 10-year average payout ratio is just under 80%, so lower increases are likely prudent given the company's desire to maintain the stated range.
Making up for mediocre dividend growth is the stock's high yield. Duke currently yields 4.7% based on Thursday's closing price of $82.72. According to Value Line, this is slightly above the average yield of 4.6% that the stock has had since 2010. The current yield looks even better when compared to the five-year average yield of 4.3%.
Using the recent closing price and expected earnings per share of $5.05 for 2020, shares of Duke trade with a forward price-earnings ratio of 16.4. This compares favorably to the average price-earnings ratio of 17.6 and 19.3 for the last 10 and five years.
While the loss of the Atlantic Coast Pipeline will remove some the expected earnings in the short term, Duke has a healthy capital investment plan that should alleviate some of this pain. Therefore, I have targeted a price-earnings ratio range of 16 to 18 for the stock. This would give a price target range of $81 to $91 using the low end of guidance. This would be a 2.1% decrease from the current price at the low end, but a 10% gain at the high end.
The dividend yield at $91 a share would still be 4%, so investors could see a total return of 14%.
Final thoughts
The Atlantic Coast Pipeline has been a headache for Duke for several years. The end of the project was a significant headwind in the quarter and will be for the year. The company can instead focus on the rest of its business following the cancelation of this project.
Quarterly results were also impacted by Covid-19, but Duke has taken measures to reduce costs that should help alleviate this issue. With the majority of commercial and industrial customers returning to operations, second-quarter results will likely be the low point for the year.
Investors able to overlook the impact from these short-term issues can take advantage of a stock paying a high dividend yield while trading at a below-average valuation. A modest expansion of the price-earnings ratio combined with the dividend yield could result in a mid-double-digit total return.
This type of return should have the eye of all investors. As such, Duke appears to a buy at the current price.
Disclosure: The author is long Dominion Energy.
Read more here:
Not a Premium Member of GuruFocus? Sign up for afree 7-day trial here.
This article first appeared on GuruFocus.
