Duke Energy (NYSE:DUK) was one of the first stocks I bought for my dividend growth portfolio. This company is one of America’s largest regulated utility companies, with a market cap of roughly $70 billion.
On August 10, I wrote my most recent article on the company. In that article, I not only explained why the stock is a good income tool but also that I’m consistently considering selling DUK. After all, I’m mainly focused on dividend growth instead of high income.
Fast forward to today, I still haven’t sold DUK. And believe me, it’s not because of a lack of trying.
DUK is just too good for me to sell. As I have significant cyclical exposure, I want to stay in the defensive sector. I also want to maintain a 2%-ish average yield for tax purposes, which requires me to keep certain higher-yielding investments.
Hence, I decided to stick with DUK.
In this article, I’ll update my long-term thesis for dividend investors using the just-released quarterly earnings.
So, let’s get to it!
Consistent Income & Safety
The absolute number one reason why I own DUK is safety. Duke is so boring (that’s a good thing in the investing world) that I rarely check its stock price. I usually check DUK about 4x per year when it reports earnings.
Incorporated in 2005 (after countless mergers), the company services more than 8 million customers in the Southeast and Midwest regions of the U.S., which includes Indiana, the Carolinas, and Florida.
While regulated utilities are dealing with risks like inflation, weather events, and rates, their business is very anti-cyclical. Sure, a red-hot economy uses more energy than an economy in a recession, but overall, utility bills are the last thing people stop paying when in financial stress – besides food, of course.
Looking at the chart below, we see that DUK fell by 40% during the Great Financial Crisis, beating other higher-yielding investments by a considerable margin.
It also has a more than decent Seeking Alpha dividend scorecard.
The company scores Bs in all categories, supported by its 4.6% yield, its 73% (non-GAAP) payout ratio instead of 19%, and consistent dividend growth, albeit at a slow rate.
On July 13, the company hiked its dividend by 2%.
Please note that DUK has not cut its dividend since it became an established company in the early 2000s. The dividend decline in the chart below is the spin-off of Spectra.
While the company’s low dividend growth rate is somewhat of a drawdown, as it barely protects investors against inflation, it’s a measure that makes sense, as DUK is heavily investing in its business. This includes renewables, nuclear energy, and other measures to future-proof this utility giant.
It is these measures that have allowed DUK to outperform the utility ETF (XLU) since the early 2000s.
Over the past five to six years, DUK has shown the same total return performance as the XLU utility ETF and the Vanguard High Dividend Yield ETF (VYM), which can be seen when looking at the ratios between these assets below.
With that said, the company continues to do well.
Slightly Lower Volumes, But Solid Balance Sheet Health
In the just-released third quarter of 2023, the company reported earnings per share of $1.59, with adjusted EPS at $1.94, compared to $1.81 and $1.78 in the previous year.
Electric Utilities and Infrastructure results were down $0.01 per share, but this was offset by an increase of $0.01 in Gas Utilities and Infrastructure and $0.16 in the Other segment.
The company reported a 1.2% decrease in volumes on a rolling 12-month basis.
This drop was attributed to industrial customers pulling back temporarily due to economic uncertainty.
However, there is optimism for a turnaround in 2024 and beyond. Customer growth from population migration and economic development is expected to drive long-term growth.
With that in mind, one of the single biggest risks facing utilities and their investors is rising interest rates. After all, utilities have loads of gross debt, posing risks for the bottom line.
DUK is expected to end this year with $75 billion in net debt. That’s more than its market cap. That number is expected to rise to $85 billion in 2025 due to aggressive investments in renewables and its network.
However, the company is expected to maintain a high-5x EBITDA leverage ratio, which means that investments end up growing EBITDA, keeping the leverage ratio flat.
Furthermore, the company has taken steps to maintain a strong balance sheet.
They are collecting deferred fuel balances and expect to recover $1.7 billion in deferred fuel costs in 2023.
The sale of the commercial renewables business will remove about $1.5 billion of debt from the balance sheet.
Duke also reached a settlement on the treatment of nuclear PTCs, which, if approved, will provide savings for customers and support credit metrics.
The company aims to achieve FFO to debt ratios of 13-14% in 2023 and 14% in 2024 through 2027. It has a BBB+ credit rating, a step below the A-range.
Adding to that, with the sale of commercial renewables completed, Duke Energy has fully transitioned into a regulated company operating in high-growth jurisdictions.
The company has also received approval for rate updates in various regions, allowing for the efficient recovery of investments, grid modernization, and resilience against storms.
Growth Expectations & Valuation
In the remainder of this year, the company is focused on managing its cost structure to offset challenges like mild weather and weaker industrial volumes.
Various measures, including agility initiatives, savings opportunities, and efficiency improvements, are being implemented across the organization while maintaining a commitment to safety and customer satisfaction.
As a result, Duke has tightened its full-year 2023 EPS guidance range to $5.55 to $5.65. The lower-than-normal winter weather conditions and a decline in volumes, attributed in part to a softening industrial load and the return of residential customers to work, have affected earnings.
Nonetheless, the fourth quarter is expected to be strong, with an EPS target of $1.50 to $1.60 per share.
With regard to the next year, the company plans to provide detailed 2024 earnings guidance and capital plans in February.
They anticipate growth from regulatory outcomes, multiyear rate plans, and storm protection plan investments.
Economic development and residential customer growth are expected to drive higher weather-normalized volumes. The company also expects increased financing costs due to higher interest rates but is actively working to lower O&M expenses.
Based on this context, and despite higher debt costs and temporary cyclical headwinds, Duke sticks to its five-year capital plan and aims for a 5% to 7% growth rate through 2027, with a focus on affordability, reliability, and clean energy.
The mix of 5% to 7% EPS growth and a mid-4% yield is expected to maintain a 10% annual shareholder return.
This brings me to the valuation.
An objective view of DUK’s valuation confirms the company’s comments.
Using the data in the chart below, we see a number of things.
- DUK is trading at a blended P/E ratio of 14.2x.
- Its multi-decade normalized valuation is 14.3x earnings.
- Analysts agree with the company’s growth outlook and see between 6% and 7% in annual EPS growth.
- Assuming the company keeps trading at a 14.3x multiple, it could return 10.5% per year through 2025.
In other words, thanks to its falling stock price, the risk/reward remains very good.
While we could see more selling if the Fed keeps rates elevated for longer, I believe the risk/reward warrants new investments at these levels, which is what I have been doing.
As I said earlier in this article, I am consistently looking for alternatives. However, DUK fits my portfolio really well, and I’m unlikely to sell it. I’m more likely to add alternatives in other areas than to sell any of my current 20 holdings.
Despite my doubts, I believe my investment in Duke Energy has proven to be a wise choice for my dividend growth portfolio.
While I’ve considered selling DUK to focus more on dividend growth, its consistent income and safety have convinced me to hold onto this reliable stock. Regulated utilities like DUK provide a steady income stream even in uncertain economic times, making them a stable choice for investors.
Despite the slow dividend growth, DUK has demonstrated resilience and a commitment to future-proofing its operations through investments in renewables and infrastructure.
The company’s recent earnings report and solid balance sheet health further support my confidence in its stability.
Looking ahead, DUK’s growth expectations and attractive valuation make it a valuable addition to my portfolio.
While I remain open to exploring alternatives, DUK continues to be a strong cornerstone of my investment strategy.