In the utilities sector, it's not hard to find utility stocks with 4% yields or even higher in some cases. What's hard to find among utilities, though, is high dividend growth. Most utilities do grow their dividends each year but by small percentages that simply allow companies to say that they have increased dividends for a certain number of consecutive years. For example, the most recent dividend increases from Duke Energy (NYSE:DUK) and Southern Company (NYSE:SO) were just 3% each. That barely beats inflation.
As a result, dividend growth investors have traditionally avoided the utility sector entirely. But there is one company - Dominion Resources (NYSE:D) - that is a rare combination of high dividend yield and high dividend growth. Last month, Dominion raised its dividend by 8%. This brought the new annualized dividend to $2.80 per share. At its current stock price, that results in a 4.1% dividend yield. Its high dividend growth is expected to continue. The company projects 8% dividend growth each year through the end of the decade.
With a 4% yield and 8% annual dividend growth from here, Dominion is a unique find in the utility sector.
Expansion Projects Fuel Earnings Growth
The reason why Dominion expects 8% dividend growth each year through 2020, which would be well above the average utility dividend growth rate, is because of the company's energy infrastructure growth strategy.
Dominion's strategic imperative is to acquire new customers, which will immediately boost revenue. Another way in which revenue can grow is through higher average bills. This is a two-fold plan to increase revenue. As a utility, Dominion can pass through regular rate increases on an annual basis. The combination of higher customer numbers and higher average bills helped Dominion grow earnings at a strong pace to start 2015. For example, last quarter customer additions and higher average bills resulted in 10% earnings growth year over year. It's very rare to find double-digit earnings growth among utility companies. In the first nine months of 2015, Dominion's operating earnings rose 7% year over year. This was still a very strong growth rate for a utility, and speaks to the progress of Dominion's growth strategy.
Future earnings growth will be provided by the completion of large expansion projects. Dominion has invested heavily in building midstream and other energy assets, which will soon come on-line and contribute to earnings growth. Construction on the Brunswick County project, a 1,358-megawatt natural gas combined-cycle facility, is nearly 90% complete and is set to start up commercial operation toward the middle of this year. Separately, construction on its Cove Point liquefaction project also is progressing on time and on budget. That project is almost half complete.
Lastly, Dominion is making a big push into clean energy. Dominion Virginia Power plans to invest $2 billion each year through 2020 in clean generation like solar in addition to the $5 billion it plans to spend on the Atlantic Coast natural gas pipeline.
Contained Interest Rate Risk
As with most other utilities, the biggest forward risk facing Dominion is rising interest rates. Higher interest rates are a headwind for companies that rely on debt financing within their capital structures. Utilities are among those types of companies, and as a result, investors should monitor debt levels closely. Fortunately, Dominion appears to have a strong credit profile and manageable debt, and rising interest rates should not significantly impact its fundamentals. In the company's last 10-K, it showed a "BBB+" rating from Standard & Poor's on its senior unsecured debt. Its junior subordinated debt is rated "BBB." These are good ratings for a utility, which is a good sign.
Dominion has $19 billion in long-term debt, which is a concern if interest rates are set to rise. But the first thing to note is that even though the Fed raised interest rates last month, future interest rate hikes are likely to take a slow and gradual pace. In addition, Dominion's debt repayment schedule is fairly evenly spread over several years. Dominion has $1.9 billion in combined 2016-2017 interest payments, along with $1.6 billion for 2018-2019 combined. Considering the company earned $1.3 billion in net profit just last year, it seems the interest expense is still manageable, even if rates rise slightly in 2016.
A Rare Utility Dividend Growth Pick
Once completed, all these projects will turn from being uses of cash to being sources of cash, which is a strong tailwind for future earnings growth. That, in turn, will pave the way for future dividend growth. Targeting 8% dividend growth per year should be easily achievable given Dominion's above-average earnings growth. And, even after including the recent 8% dividend raise, Dominion's dividend payout ratio is 73% of 2016 forecasted earnings per share. Dominion management has set a benchmark payout ratio of 70%-75% of earnings per share, so that is right-in line with expectations.
Dominion's 8% dividend raise last month is the 13th consecutive year in which its annual dividend rate rose from the previous year. If the company can make good on its plan to raise dividends by 8% through 2020, Dominion will be a rare find of high dividend growth in the utility sector.
Disclaimer: This article represents the opinion of the author, who is not a licensed financial advisor. This article is intended for informational and educational purposes only, and should not be construed as investment advice to any particular individual. Readers should perform their own due diligence before making any investment decisions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.