The utilities sector continues to encounter numerous fundamental challenges. Electricity demand continues to be stagnant in most parts of the America, particularly residential demand, which has remained flat since 2006. This stagnant demand is hurting companies when they also have to spend more capital to advance their systems. These heavy expenditures, when spread over low growth consumption, will lead to input cost increases, resulting in depressed margins and financial difficulties.
Wholesale power producers are also having difficulties in the face of the demand to offset low power prices and the rapid expansion of renewable energy. These combined challenges are prompting companies to reconsider existing strategies and think about new business models. Consequently, many companies continue to close coal and some nuclear plants. Entergy (ETR), Duke Energy (DUK), Edison International (EIX) and Dominion (D) have shut down nuclear plants, and Exelon Corporation (EXC) likewise plans to retire nuclear plants in the face of these headwinds the entire industry is facing.
Taking this turbulent environment into consideration, in this article, I pick three companies, out of which NextEra Energy (NEE) and PPL Corporation (PPL) are rising to meet challenges and generating steady growth. The third company, Exelon, is having some difficulties and does not look like a good stock to buy. Digging into these companies, I keep my focus on their dividend stability by analyzing how their business plan, financial situation and future prospects are likely to sustain dividends.
How NextEra Energy is a Safe Investment
NextEra Energy's operating performance is driven primarily by its two subsidiaries, Florida Power & Light Company [FPL] and NextEra Energy Resources [NEER]. FPL is one of the largest rate-regulated electric utilities in the U.S., serving about 4.6 million customers in Florida. NEER, jointly with affiliated entities, is the largest generator of renewable energy from the wind and sun in North America. So far, its development program and other initiatives to enhance productivity and reduce business costs are working.
At FPL, aggressive investment in the business is improving consistency, lowering fuel costs, reducing emissions, and enhancing the value proposition for its customers. FPL's average regulatory capital employed for the recent quarter increased $2.4 billion, or about 9.3% over the past year quarter. The company is also making more investments at NEER. Recently, it contracted a new renewable project that will strengthen its position as the largest generator of renewable energy from the sun and wind, signing a long-term power purchase agreement for a new U.S. wind project of around 200 MW. This agreement brings its total new contracted U.S. wind development portfolio to around 1,175 MW. In Q3 of 2013, NEER brought into service a 125-MW Canadian wind project and is expecting additional Canadian wind projects of about 475 MW to enter into service in 2014 and 2015.
With its aggressive investment strategy to improve production, NextEra Energy is looking to generate 5% to 7% growth, and its recent quarter result justifies these future projections. At the end of the recent quarter, its net income was standing at $698 million, compared with $415 million in the past year quarter. For the full year, it is looking to generate EPS of around $5/share. Based on a payout ratio of 54% and predicted 5-7% growth in income, NextEra Energy's current dividend growth rate is sustainable. The table below shows its dividend increases over the past five years.
How PPL is a Safe Investment
PPL Corporation is an energy and utility holding company that, through its subsidiaries, is engaged in the generation and marketing of electricity in the northeastern and western U.S., as well as in the delivery of electricity to Pennsylvania and the U.K. With a diversified business model, its strategy is to optimize energy supply margins and mitigate near-term volatility in both earnings and cash flows. More explicitly, the company's strategy is to optimize value from its marketing portfolios and competitive generation.
To do this, PPL is matching energy supply with load under contracts of different durations with creditworthy counterparts. This enhances profits while efficiently managing exposure to energy and fuel price instability, operational risk and counterpart credit risk. With this strategy, the company has been generating strong top and bottom line growth. On average, its revenue growth is standing at 18.2%, while the industry average is at 3.6% over the past three years. The company has demonstrated this trend again in the recent quarter by generating earnings of $410 million compared with $355 million in the past year quarter. Additionally, its solid Q3 performance allows the 2013 forecasts to increase from $2.35 to $2.45 per share.
PPL's operating cash flows are not providing cover to dividend payments due to massive capital expenditures. However, based on a payout ratio of around 59%, its dividends are manageable. At the moment, PPL is undervalued, as it is trading at only 11.9 times to earnings while the industry average is at 20.0. Overall, with its diversified business model, solid business strategy and strong top and bottom line growth, I believe PPL Corporation has the ability to sustain dividends.
How Exelon Is Not a Safe Investment
Exelon Corp. is a utility services holding company engaged, through its subsidiaries ComEd, PECO and BGE, in the generation and energy delivery businesses. Exelon recently reduced its quarterly dividend by 41% to 0.31/share. The company reduced its dividend in order to make more payments to lower debt levels. Obviously, divided cuts are not appreciated by investors, and this is no different here. Since that time, Exelon's stock price dipped down and is now trading at its lowest point over the past five years.
Though the company has been working to improve its top line growth, weakness in margins-mainly due to weak gas and power prices-continues to put a dampening effect on its earnings and cash flows. At the end of the recent quarter, the company has increased EPS by only 0.01/share, but lowered the full year guidance range from 2.60/share to 2.40/share. Further, I believe an imbalance between demand and supply, and weak power prices will continue to put pressure on the company's future earnings growth and cash generating ability. At the moment, its dividend stability is also questionable primarily due to cash flows, which are not providing cover to dividends. Secondly, this is due to a payout ratio that is standing at 89% over the last twelve months.