Utility stocks have remained an important component of investors' income portfolios as the stocks offer stable earnings and high dividend yields. Duke Energy (DUK) is among the leading high quality utility companies of the U.S. and has remained an admired investment option among income-seeking investors. I am bullish on DUK and recommend income-seeking investors to buy the stock for their income portfolios for 2014, as the stock offers a high and sustainable dividend yield of 4.6%. Also, the company has anticipated enjoying an EPS growth rate of 4%-6% through 2015.
Regulated Business Operations and Rate Base Growth
DUK has been targeting to expand its regulated business operations in future years, which will drive its bottom line growth. News surfaced that the company has hired Citigroup to assist with plans for a possible sale of its Midwest assets, though it should be noted that the company has not made any formal announcement or statement concerning a possible sale. An increase in regulated operations for DUK will provide more earnings stability and give a boost to investor confidence. Also, capital spending in the future, in an effort to expand its regulated operations, will be recovered by the company through rate base increase, which will portend well for its future earnings.
The company has attractive investment opportunities in the Carolinas and Florida. In the Carolinas, DUK has filed a request with the South Carolina commission for an approval to build a 750MW combined cycle plant. If the company gets the approval on its filed request it will begin work on the plant and could bring it online in 2017. In the Carolinas, it could also benefit from new wholesale contracts. In Florida, the company got an approval to replace lost capacity as a result of plant retirements. The company is evaluating new generation options and is expected to finalize its new generation plans by the mid of 2014. Once the new generation plans are finalized as expected, it could begin construction work in the first half of 2015, with the expected completion being by 2018.
DUK also has plans to spend aggressively towards renewable energy resources to optimize its generation fleet. The company estimates that it will incur $5-$6 billion of spending on renewable energy sources and environmental compliance over the next decade. The spending will allow the company to grow its earnings and increase exposure to its regulated business operations, providing greater earnings visibility and stability.
Also, in the next two years, the company foresees to improve its cost structure through merger-related synergies, which will result in annual cost savings of more than $500 million by 2016. Cost reduction measures will have a positive impact on future earnings growth.
DUK has successfully completed several regulatory proceedings in 2013, including the proceeding in Florida and the Carolinas. As we move into 2014, the company is awaiting an outcome on its cost-based capacity filing. The outcome is expected in the first half of 2014. Once the company gets a ruling on the cost-based capacity filing, it will disclose its future road map for Midwest assets. I believe DUK will sell these assets as the performance of the assets remains weak and accounts for only 5% of total revenues.
Apart from the strengthening of its regulated operations and rate base growth, DUK's current dividend yield of 4.6% remains an important stock price catalyst. The company has been consistently paying dividends for the last 88 years. Dividends offered by the company have been increasing constantly and are supported by its healthy dividend coverage ratio, as shown below. Last week, DUK declared a quarterly dividend of $0.78, payable on March 17, 2014. The following table shows the payout ratios, annual dividends and dividend coverage ratios for the company from 2009 to 2013.
Source: Company Reports and Calculations
(Note*: 2013 calculations are based on reported financial performance and estimates. Dividend Coverage ratio = Operating Cash flow/Annual Dividend.)
I believe DUK is a good stock for investors' income portfolios for 2014. The stock offers a high dividend yield of 4.6%, which is supported by its solid cash flows. Also, rate base growth, as a result of capital spending, and cost reduction measures will portend well for the company's future earnings. Moreover, its solid business fundamentals, solid management team and increasing exposure to regulated operations support my bullish stance on the stock.