Duke Energy Stock is my safest dividend investment (NYSE: DUK)
On June 26, 2020, I wrote an article titled “Duke Energy: One Of The 6 Must-Own Dividend Stocks”. Duke Energy (DUK) was indeed one of the top 6 stocks in my Dividend Growth Portfolio, which I created in June 2020. I now have 22 different stocks in my portfolio. 2 of them are utilities – the full list can be seen in my Seeking Alpha bio. When buying stocks, I always look for quality first. However, I also look for stocks that I like. Companies that interest me. I also own actions that make sense. Duke Energy is one such stock. I don’t know where the stock trades most of the time. I couldn’t even tell you if it’s at its highest level or 5% below. Duke is boring. And that’s a good thing because it’s the safest dividend-paying stock in my portfolio.
In this article, I’ll write a much-needed update and explain why I love Duke so much.
Put the “Q” in quality…
With a market capitalization of $81 billion, Duke is the second largest regulated electric utility company in the United States. Based in Charlotte, North Carolina, the company operates in the Carolinas, Indiana, Ohio and Kentucky, as well as the Sunshine State, Florida.
Duke generates approximately 86% of its profits from regulated electricity. 9% gas and 5% commercial renewables.
Utilities are among the most defensive investments in the world for the obvious reason that people and businesses need electricity. The only cyclical aspect of the business is that higher economic growth increases electricity needs. Industrial and commercial demand is much more volatile than residential demand, which is driven primarily by secular trends like technology adoption and migration. In 2021, the company recorded a growth rate of 1.6% in electricity customers. This comes from growth of 1.8% in the Carolinas and Florida (1.8% each) and growth of only 0.8% in the Midwest. This makes sense as people have moved to the Carolinas and Florida (among other states) from higher taxed states.
In 2022, Duke expects to grow total retail electricity volumes by 1.5% with up to 2.0% growth in industrial demand due to higher economic output.
Meanwhile, the company continues to invest in cleaner energy sources, which increases capital expenditure (“CapEx”) as I will show you in this article, but it reduces operating costs. global. Operations and maintenance costs have fallen 1.4% per year since 2016 thanks to the move away from coal, a modernized network and the company’s ability to leverage its size to somewhat offset the ‘inflation.
In 2021, Duke generated $5.24 of adjusted earnings per share. The company’s initial forecast was $5.00 to $5.30. Through 2026, the company expects to grow earnings by 5-7% per annum with EPS of $5.45 in 2022. Duke expects to benefit from the aforementioned increase in customer numbers and increases in rates, among other factors.
That said, there is no reason to buy utility companies for capital gains. However, it is important to buy utility companies that do not dilute stocks to the point that investors receive dividends but end up with high capital losses should they want to sell. The fact is that utility companies issue shares to finance projects. Duke had 700 million shares outstanding in 2017. In 2021, the company had 769 million shares outstanding. While stock buybacks increase the value of each share, stock issuance achieves the opposite. However, this is not a big problem for DUK. While total net income has increased 110% since 2007, earnings per share have increased 6%. That might not sound like a lot, but it factors in the massive dilution of the company’s stock during this time.
The stock dilution isn’t going to end any time soon. The company has a CapEx plan of $63 billion over 5 years. Between 2022 and 2026, the company is expected to spend the same on modernizing its network and pushing towards net zero through investments in nuclear, renewables, storage and hydroelectricity. Over the period 2027-2031, CapEx will likely end up exceeding $70 billion.
The graph below shows the company’s funding gap, although the high level of net debt disrupts the visibility of other indicators a bit – I apologize. What we’re looking at is about $9.7 billion in gross CapEx last year. Operating cash flow was $8.3 billion. This means that the company needs external funds to cover the CapEx. Free cash flow has always been negative since Duke (and its peers) started increasing CapEx after 2014. However, keep in mind that the company also pays out a 3.7% dividend yield. This adds another $3.0 billion to the funding gap. It’s no surprise, then, that stock dilution has accelerated with an increase of nearly $28 billion in total long-term debt since 2014.
But again, know that the company is driving value, as earnings per share growth is expected to remain positive – and it has been in the past as well.
It also helps if the company’s total equity (total assets minus total liabilities) is in a steady upward trend, which means that money from investments is not wasted. It ends up as “value” on the balance sheet.
In this case, quality is the company’s ability to move its business to net zero and modernized infrastructure without sacrificing the bottom line. The company will make well over $10 billion in annual CapEx to exit coal by 2035. That will require debt. The good thing is that the company’s history has shown that it is possible to accelerate CapEx without destroying value through leverage. In this case, it also comes with stronger earnings growth, as the company raises prices to invest in renewable energy. As a result, the company has a BBB/Baa2 balance sheet, a 112% funded pension plan and cost management that allows for faster earnings growth.
…and the “Y” in the yield
High yield investors have been in a tough spot since the pandemic. Since the pandemic, dividend yields have fallen off a cliff. Before the pandemic, the return of the S&P 500 was close to 2%. It is now below 1.40%. The High Yield ETF (VYM) returns just 2.9% instead of over 3.0%, and Utilities (XLU) returns just 2.8%. DUK’s yield is around 90 basis points above the XLU yield and 30-40 basis points below its longer-term median.
In other words, the definition of “high yield” changed after the pandemic. Investors who wanted a high return were more or less forced to buy energy stocks or certain companies they might not have invested in under “normal” circumstances. I know for a fact that many of the retail traders I talk to started buying mortgage REITs and high yield ETFs just to get a higher return.
The chart below shows the difference between Duke’s dividend yield and the S&P 500’s dividend yield. It’s about 233 basis points, which is roughly the 5-year average. Additionally, and with respect to stock dilution, the stock performed the same as the Utilities ETF and the High Yield Vanguard ETF, which includes stocks like PepsiCo (PEP) , Coca Cola (KO) and banks like JP Morgan (JPM). If we zoom out further, the performance is slightly worse, but overall it’s a net total return for a stock with a yield close to 4%.
Unfortunately, but not unexpectedly, dividend growth is weak. Since 2015, dividends have increased by 3.1% per year. It beats pre-pandemic inflation and the impact on an already high yield is greater, but it’s not something that will excite dividend growth investors. But that’s okay because these numbers are justified by earnings growth and the numbers are sustainable in the long run.
In terms of valuation, we are dealing with a market capitalization of $81 billion and a net debt of $68 billion. That gives us an enterprise value of $149 billion. That’s 12.1x this year’s EBITDA consensus of $12.3 billion.
Historically speaking, this is an “OK” price. Nothing exciting, but also not a price that should keep people from buying. Additionally, as seen in the bottom half of the chart below, utilities appear to be bottoming against the S&P 500. This is likely due to the 10-year yield losing momentum as investors know that “aggressive” Fed rate hikes will put pressure on inflation. to get up.
DUK stock price seems to be working on a breakout near $107-$108. Year-to-date, the stock is up just over 1% against an 11.6% correction for the S&P 500. I think this breakout could be real and I wouldn’t be surprised if the stock was trading at $110 2-3 months from now.
Duke Energy is one of my favorite stocks in my portfolio – and one of the initial six positions. The company is extremely boring, which is a good thing. Most of the time I have no idea where it is trading and I don’t frequently check its quarterly results – unless I am checking to see if the company is still on track to generate value , as I have done in this article.
DUK is a good stock for high yield dividend investors and dividend growth investors who want to add higher yield to their portfolio. The company is in fantastic shape and well positioned to achieve several things, including hitting net zero without letting high debt destroy its balance sheet, growing the business without neglecting earnings growth, and paying a high dividend without hitting its growth targets.
Yes, dividend growth is low, but the yield gives us a nice premium to the market. Additionally, investors don’t buy a stock without potential capital gains, as it keeps pace with its utility and high-yield peers.
As for the timing, I think the stock is about to go up. Regardless of that, I think DUK is a great company that investors can buy and add to at almost any price because upside outliers are very rare. The valuation is good and I will probably reinvest some dividends next month.
(Disagree? Let me know in the comments!