Contrary to popular belief, utility stocks can offer more than just income. There are plenty of names in the sector that are trading below their intrinsic values while also providing high levels of income.
In this article, we will examine three names that offer at least 20% total returns based on my analysis, suggesting that they are hitting the sweet spot of growth and income.
ALLETE
As the parent company of Minnesota Power, ALLETE, Inc. (ALE, Financial) provides electricity to 146,000 customers in northeastern part of the state. The company also has other business, including ALLETE Clean Energy and Superior Water. ALLETE has a market capitalization of $3.3 billion and generated revenue of nearly $1.2 billion in 2020.
ALLETE raised its dividend by 2% for the March 1, 2021 payment date, extending the company’s dividend growth streak to 11 years. The dividend has a compound annual growth rate of 3.6% over the last decade.
If the company keeps to its traditional schedule, then shareholders are likely to see the next increase sometime early in 2022. Currently, shareholders are receiving $2.52 of dividends per share. Analysts expect that ALLETE will earn $3.16 this year, resulting in a projected payout ratio of 80%. This compares to the 10-year average payout ratio of 68%, which likely explains the lower than usual dividend increase that was given early this year.
Still, shares of ALLETE yield 4.2%, which is slightly ahead of the long-term average yield of 3.7%, according to Value Line. This is also more than three times the 1.3% average dividend yield for the S&P 500 index
ALLETE closed Friday’s trading session at $60.11, which equates to a forward price-earnings ratio of 19, matching the average multiple since 2011.
Using the GuruFocus Value Chart, ALLETE looks to trade at a steep discount to its intrinsic value.
ALLETE has a GF Value of $72.36, giving the stock a price-to-GF-Value ratio of 0.83. The stock would return more than 20% if it were to reach its GF Value. Factor in the dividend yield and total returns could stretch into the mid-20% range.
ALLETE likely isn’t the most well-known utility stock in the sector as it doesn’t have the largest customer base. That said, the company contains a variety of utilities, allowing for some diversification. ALLETE also has a decent dividend growth streak going, and the company did raise its dividend each year of the last recession prior to pausing its growth in 2010. In addition to a high yield, ALLETE is trading well off of its GF Value, implying the potential for strong gains for the stock.
ONE Gas
ONE Gas, Inc. (OGS, Financial) was spun off by parent company ONEOK, Inc. (OKE) near the beginning of 2014. The resulting company is a leading natural gas utility, with two million total customers and dominant market share in both Oklahoma and Kansas. ONE Gas is also one of the larger players in Texas. The company has annual revenues of $1.5 billion and is valued at $3.5 billion today.
ONE Gas raised its dividend 7.4% for the March 5, 2021 distribution, giving the company a growth streak of seven years. The dividend has a CAGR of 12.5% since 2015, the first year that ONE Gas paid a dividend in each quarter. Dividend growth has slowed recently, but is still at a very high rate compared to most utility companies.
With expected dividends of $2.32 for the year and analysts calling for $3.84 of earnings per share, ONE Gas has an estimated payout ratio of 60%. This is slightly above the five-year average payout ratio of 55%, but on the low side of the company’s peer group.
The stock yields 3.5% at the moment. For context, ONE Gas has yielded, on average, 2.4% over the last five years. Shareholders are being paid more than a full percentage point above what the stock typically pays.
Even better, shares look inexpensive today. Using the most recent closing price of $66.03 and analysts’ estimates for 2021, ONE Gas has a forward price-earnings ratio of 17.2. Shares have averaged a multiple north of 23 times earnings since 2016.
The GF Value chart also shows that the stock trading below what it’s worth.
ONE Gas has a GF Value of $83.22, giving the stock has a price-to-GF-Value ratio of 0.79. This implies that ONE Gas is undervalued by 26% relative to its GF Value. Combined with the dividend, total returns could begin to approach 30%.
ONE Gas benefits from its position as the prime supplier of natural gas in two states and a decent sized presence in another. The company’s dividend growth streak has been solid since being spun off and the yield is higher than shareholders are accustomed to seeing. Total possible returns are strong as well, as ONE Gas appears to be one of the more undervalued names in the utility sector.
Pinnacle West
Pinnacle West Capital Corporation (PNW, Financial) is the holding company for Arizona Public Service Company. The company provides electricity to 1.3 million customers in most parts of Arizona. Pinnacle West has a market capitalization of $7.5 billion and annual revenues of $3.6 billion.
Shareholders received a 2.4% dividend increase for the upcoming Dec. 1, 2021 payment date. As a result, Pinnacle West now has a dividend growth streak of 10 years. The dividend was paused from 2008 through 2011, but it has a CAGR of just under 5% since this time.
Pinnacle West will distribute $3.34 of dividends per share in 2021. With the market expecting earnings per share of $5.19, the projected payout ratio is 64%. This is nearly in-line with the 10-year average payout ratio of 63%.
Pinnacle West yields 5.2% using the new annualized dividend of $3.40. This is superior to the stock’s average yield of 4% since 2011 and four times the average yield of the market index.
With a current price of $65.26, Pinnacle West trades at 12.6 times estimates for the year. Shares have an average price-earnings ratio of 15 over the last decade.
The GuruFocus Value chart also places the current price at a discount to the intrinsic value.
Pinnacle West has a GF Value of $88.84. Using the current share price, the stock has a price-to-GF-Value ratio of 0.73. Investors could be looking at a return of 36% if the stock were to reach its GF Value. The contribution from the dividend could push the total return into the 40% range.
Pinnacle West is the largest of the utility stocks discussed in this article and offers the highest total possible returns based on my valuation method. The dividend was held steady for a number of years, but the growth since has been decent. The yield is also very generous and the payout ratio is near the long-term average. Potential total returns would be impressive for any company in any sector, let alone for one in the utility sector.
Final thoughts
ALLETE, ONE Gas and Pinnacle West might be three of the lesser-known members of the utility sector, but each name pays a high yield and trades below its intrinsic value. Each name also offers a high yield and the possibility for as much as 40% total returns at current prices. For investors looking for higher capital gains in addition to income, these three names could be an excellent starting point for further research.
