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Summary

  • DUK remains an attractive investment despite risks attached with increase in treasury yield.
  • Company offers solid dividend yield of 4.3%.
  • Dividends offered are backed by cash flows, evident by its healthy dividend coverage.
  • DUK could update capital plan by increasing planned capital expenditure in the near future.

The utility sector has outperformed the broader market in the first half of 2014. Utility sector ETF (NYSEARCA:XLU) is up 14% year-to-date, outperforming the S&P 500 (NYSEARCA:SPY), which gained only 6.71%. The outperformance of the utility sector can be attributed to a drop in treasury yields (as utilities are dividend paying stocks that remain sensitive to treasury yields), an improving sales trend of utility companies and an improvement in merchant markets. However, the utility sector is exposed to risks, which could adversely affect the sector's performance in the future. Rising treasury yields and rotation out of defensive sectors are among the most prominent risks faced by the sector. Despite the risks faced by the sector, there is one company, Duke Energy (NYSE:DUK), which I believe remains an attractive investment in the sector. The company has been delivering a healthy financial performance, has a strong balance sheet, offers an attractive dividend yield of 4.3%, and its capital expenditure for the future remains attractive.

The company's planned capital expenditures will result in rate base growth of 6% in the latter half of the decade. DUK is expecting approximately $5 billion-to-$6 billion of environmental compliance expenditures through 2023, which will provide rate base growth. Also, most of the planned investment by DUK will be done in the Carolinas, Florida and Indiana, which have a history of constructive rate outcomes, which portends well for the stock. I believe the company could increase its planned capital expenditure by updating its capital plan, as the current plan does not include capital expenditure opportunities in Interstate Pipeline, the development of a solar project in the North Carolinas and spending associated with excavating four additional plants (related to coal ash).

Financial Performance and Dividend
In addition to attractive capital expenditure for the future, the company has been delivering a satisfactory financial performance in the recent past and offers solid dividends. The company reported an EPS of $1.17 in 1Q14, beating consensus estimates of $1.12. The earnings beat for the quarter was driven by favorable weather and higher volume in Brazil. Also, the load growth remained solid in the quarter. DUK's normalized weather sales were up 2.6%, as commercial, residential and industrial demand increased by 3.6%, 2.9% and 0.4% year-on-year. The company reaffirmed its 2014 EPS guidance range of $4.45-$4.60 and EPS growth of 4%-6% through 2016.

The company also offers a solid dividend yield of 4.3%, which is backed by its operating cash flow yield of 12.9%. The company has been consecutively paying dividends for the last 88 years. Also, the company has been consistently increasing dividends in the past; recently, DUK announced a quarterly dividend of $0.795, up 1.92%. The dividend is payable to shareholders on 16th September, 2014. The company has targeted a long-term payout ratio of 65%-to-70%. Dividends offered by the company are safe and backed by operating cash flows. The following table shows the annual dividends, payout ratio and dividend coverage ratios (operating free cash flow/annual dividend) from 2009 to 2013.

2009

2010

2011

2012

2013

Annual Dividends/Share

$2.88

$2.94

$3.00

$3.04

$3.12

Payout Ratio

-

95%

75%

95%

90%

Dividend Coverage

2.85x

3.50x

2.70x

2.60x

2.65x

Source: Company Reports and Calculations

Also, the company has a strong balance sheet, evident in the fact that different credit rating agencies have assigned an investment grade credit rating to DUK, as shown below.

Source: Investors Presentation

Conclusion

Despite the risks faced in terms of an increase in treasury yield and rotation out of the defensive utility sector, DUK remains an attractive investment for investors' income portfolios, as it offers a solid dividend yield of 4.3%. Dividends offered by the company are backed by cash flows, evident by its healthy dividend coverage, shown above in the table. Also, the company could update its capital plan by increasing its planned capital expenditure in the near future, probably during the next month's earnings release, which will portend well for the stock's performance.

Source: Duke Energy Retains Importance For Investors' Income Portfolios