In the U.S., upgrading the nation’s infrastructure has been a strong need for years. With things like bridges, highways and power grids suffering from old age, infrastructure spending has been in focus. President Trump’s recent $2 trillion plan to address the U.S.’s aging infrastructure certainly turned some heads in the investing world simply due to its enormous size and breadth.
Should it come to fruition, many infrastructure stocks stand to gain from spending to support the next generation of growth. One such stock is Duke Energy Corp. (DUK, Financial), one of the largest providers of power in the U.S. The company has paid dividends to shareholders for 93 years consecutively, and the stock has a yield that is in excess of double that of the broader market.
We like Duke for its long dividend history, its entrenched position in its markets and its ambitious capital expenditure plans that should fuel future growth.
Business overview
Duke Energy began its life by powering a single cotton mill in rural South Carolina in 1904. Since then, the company has expanded to become one of the largest energy providers in the country, producing in excess of $25 billion in annual revenue. In addition, it trades for a market capitalization of $65 billion, so its size and stability are attractive to risk-averse dividend investors.
Duke reported second-quarter earnings on Aug. 6. Results were strong, giving management the confidence to reiterate its guidance for the full year.
Electric Utilities and Infrastructure saw income of $809 million, up 14% year over year. The company noted higher base rates and rider revenues as sources of strength during the quarter.
Gas Utilities and Infrastructure income was $40 million, up 43% year over year, while the Commercial Renewables segment saw its income more than double to $86 million from the prior-year period.
Duke says its earnings per share guidance is unchanged at $4.80 to $5.20, with our estimate unchanged after second-quarter results at $5, the midpoint of guidance. Duke continues to expect to achieve long-term earnings per share growth of 4% to 6% annually.
Growth prospects
As mentioned, Duke believes it can achieve 4% to 6% growth in earnings per share for the foreseeable future. We are taking a cautious approach and assuming 4% annual growth. The company’s growth is contingent upon its ability to efficiently utilize its $37 billion in long-term capital expenditure spending, as well as rate case rulings in the markets it serves.
Utilities of all types rely upon local governments approving their rate cases, and while Duke has good relationships with the relevant parties in its service areas, a key risk for any utility is its ability to pass along rising costs for things like infrastructure spending to its customers. We have no reason to believe Duke won’t be able to continue to do this, but it is a risk given that rate case increases are the key driver of growth for just about every utility company.
The company’s Atlantic Coast Pipeline has faced cost overruns and is now facing significant legal challenges, either of which could cause the project to be delayed significantly, see a much higher final cost or be scrapped altogether.
On the bright side, Duke continues to see low single-digit customer growth in its service areas and, as mentioned, it sees steady rises in rates over time.
Finally, Duke issues shares at a rate of approximately 5% annually over time to fund growth, acquisitions, etc. This leads to a headwind to earnings per share growth over time, but the company has made it work thus far.
Strong cash generation supports the high yield
Duke has a 4.2% dividend yield today, even though shares trade near its all-time high. That is in-line with the historical yields the stock has had in the past decade as share price appreciation and dividend growth have been roughly congruent. The dividend is also quite safe as the company’s earnings have been fairly stable, as one would expect for a utility, and the payout ratio has gradually drifted lower. Today, the payout ratio is 74% of this year’s earnings, so we see Duke’s dividend as attractive for risk-averse investors.
The company has generated just over $3 billion in operating cash flows so far this year through two quarters, and the dividend costs about $2.8 billion annually. Duke’s recession resistance is also excellent given its defensive nature, as customers will use power irrespective of economic conditions. Thus, we believe Duke’s dividend is well supported by both earnings and cash flows.
Valuation analysis
Duke’s share price, as mentioned, is very near its all-time high today at $90. The stock has outperformed the broader market, as measured by the S&P 500, over the past year excluding dividends, gaining 11% versus a 3% gain for the S&P 500. Including dividends, that outperformance gap grows thanks to the company's superior yield.
The stock trades at 18 times our earnings per share estimate for this year of $5, which is a slight premium to our assessment of fair value at 17 times earnings. Duke’s price-earnings multiple, unsurprisingly, hasn’t moved around much in the past decade given the stable nature of its earnings. Even at all-time highs, the stock offers investors a reasonable entry point as we see just a 1% headwind to total returns from the valuation over the next five years.
Final thoughts
While we’d prefer Duke Energy to trade for a slightly lower valuation, we still see meaningful total returns for the stock in the years ahead. In addition, Duke’s stability and enormous size and scope allow for risk-averse investors that want exposure to infrastructure spending in the U.S. to do so with a company with a very long track record of earnings and dividends.
We see total returns around 7% given that the dividend is just over 4%, while earnings growth of 4% will be partially offset by a small headwind from the valuation. Given this, we rate the stock a hold due to its total return profile, but note that it offers income-oriented investors a very safe 4%-plus yield.
Disclosure: I am not long any of the stocks mentioned in this article.
Read more here:
- Why Total Is One of the Top Oil Supermajors for Dividends
- One of the Highest-Yielding Stocks in the S&P 500
- Kroger: Recession-Resistant Consumer Staples Dividend Stock
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
