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Utility stocks have remained an admired investment choice for income-seeking investors with a low risk appetite. 2013 has been a tough year for the utility sector, as it has underperformed the market; the utility sector ETF (NYSEARCA:XLU) has returned only 7.8% year-to-date, in contrast to the S&P 500's total return of approximately 30%. The relative underperformance for the utility sector can be attributed to the rising Treasury yields, construction cost uncertainties for some utility companies, lower PJM capacity revenues and increasing risk appetite of investors as the U.S. economy begins to improve. The following graph shows the recent trend of the rising 10-Year Treasury yield.
(click to enlarge)
Source: Yahoofinance

In this article, I will be discussing three utility companies regarding whom I am bullish. I recommend income-seeking investors to buy these stocks for their 2014 income portfolios. The three utility companies, which I will discuss below, are Duke Energy (NYSE:DUK), PPL Corp. (NYSE:PPL) and American Electric Power (NYSE:AEP). All three companies have solid dividend histories, are expected to experience decent earnings growth in the future and have delivered healthy financial performances in the recent past.

Duke Energy
DUK is among the leading utility companies of the U.S. and has delivered a healthy financial performance in the past. The company offers stable earnings, as more than three quarters of total earnings are derived from regulated operations. The company has been targeting cost saving initiatives and improving efficiency of its generational fleet to boost its earnings growth. Also, to strengthen its bottom line results and to enhance its generational capacity, the company is focusing on renewable energy sources and international business operations. These initiatives will fuel earnings growth for the company in coming years; DUK anticipates that it will enjoy a decent earnings growth rate of 4%-6% in the long term.

DUK offers a high and sustainable dividend yield of 4.5%, which makes it a good investment choice among income-seeking investors. The company has been paying quarterly dividends consistently for the last 87 years. Also, the company has a healthy dividend coverage ratio, as shown below in the table, which indicates dividends offered by the company are safe. Moreover, the company has a solid balance sheet and holds investment grade credit ratings assignment by different credit rating agencies; S&P and Moody's have assigned BBB+ and Baa1 credit ratings, respectively, to DUK. The table below shows the dividend coverage ratios, payout ratios and annual dividends per share for DUK from 2009 through 2013.

(Note*: Dividend Coverage ratio = Operating Cash flow/Annual Dividend. Also, 2013 calculations are based on YTD financial performance and estimates)

Dividend Coverage

Payout Ratio

Annual Dividend/Share

2009

2.85x

-

$2.88

2010

3.50x

95%

$2.94

2011

2.7x

75%

$3

2012

2.6x

95%

$3.04

2013

2.65x*

90%*

$3.12*

Source: Company Reports and Calculations

PPL
PPL is among the highest quality and leading utility companies of the U.S. PPL has a geographical diverse revenue base, as it has operations in the U.K. and U.S. As business conditions remain tough for competitive power producers, PPL has been aggressively working to expand its regulated operations, which will provide more earnings stability and earnings growth in coming years. PPL is anticipating that it will enjoy a healthy rate base growth of 8% on average, from 2013 through 2017, as it will expand its regulated operations. Also, the company recently got an approval from Ofgem in the U.K. for fast tracking its 8-year business plan, which will result in cost savings, more revenue certainty and incremental annual revenues. The following chart shows the forecasted regulated rate base growth for the company.
(click to enlarge)
Source: Company Reports

Other than the expansion of regulated operations, which will provide earnings growth, PPL offers a high dividend yield of 5%. The company has a modest payout ratio of approximately 60%, and has consistently increased its dividends in recent years, as shown in the table below. Also, dividends offered by the company are safe, as they are backed by solid cash flows, indicated by the healthy dividend coverage ratio. Also, PPL has a healthy balance sheet, and S&P and Moody's have assigned BBB and Baa3 credit ratings, respectively, to the company. The table below shows the dividend coverage ratio, payout ratio and annual dividend per share for PPL from 2009 through 2013.

Dividend Coverage

Payout Ratio

Annual Dividend/Share

2009

3.6x

-

$1.38

2010

3.6x

63%

$1.40

2011

3.3x

51%

$1.40

2012

3.3x

60%

$1.44

2013

3.25x*

59%*

$1.47*

Source: Company Reports and Calculations

American Electric Power
Earnings offered by AEP are stable, as approximately 90% of total earnings are earned from regulated operations. Similar to PPL, AEP has been expanding its regulated operations, which will provide earnings stability and growth in future. AEP has been undertaking initiatives to expand its regulated transmission operations, which according to me, remain a key to its future earnings growth. AEP plans to spend approximately $5 billion towards the expansion of regulated operations, in the next three years, which will fuel earnings growth; AEP has estimated that in the next five years, earnings of its regulated transmission business will grow 3x to $0.65 in 2018 from $0.16 in 2013. Also, AEP's cost control initiatives will have a positive impact on future earnings; the company has plans to maintain flat operational and maintenance expenditures at $2.80 billion from 2013 to 2016.

AEP also offers a safe dividend yield of 4.3%, backed by its strong dividend coverage ratio of 3.9x, which makes it a good investment choice for income-seeking investors. Also, the company has been consistently increasing its dividends over the years. Moreover, AEP holds investment grade credit ratings of BBB and Baa2, assigned by S&P and Moody's, respectively. The table below shows the dividend coverage ratios, payout ratios and annual dividends per share for AEP from 2009 through 2013.

Dividend Coverage

Payout Ratio

Annual Dividend/Share

2009

3.2x

55%

$1.64

2010

3.25x

67%

$1.71

2011

4.2x

46%

$1.85

2012

4.1x

72%

$1.88

2013

3.9x*

80%*

$2.00*

Source: Company Reports and Calculations

Conclusion
I am bullish on the three utility companies mentioned above. The companies offer attractive dividend yields and remain good investment options for income-seeking investors for 2014. The companies have significant regulated operations and have been taking further initiatives to increase their regulated operations, which provide earnings stability and reduce risk. Also, analysts have projected decent next five-year growth rates for the three companies, as shown below in the table. Moreover, current valuations remain attractive for the companies, as they are trading at cheap forward P/Es in comparison to the utility sector's forward P/E; DUK, PPL and AEP has forward P/Es of 15x,13.5x and 13.9x, respectively, in comparison to the utility sector's forward P/E of 15.5x.

DUK

PPL

AEP

Utility Sector

Next 5-Year Growth rate est.

3.5%

5%

4%

-

Forward P/E

15x

13.5

13.9x

15.5x

Source: Yahoo Finance and wsj.com

Source: 3 High-Yield Utility Stocks To Buy For 2014