This article reviews 5 Central United States regulated utility stocks that appear fairly valued and offer above market dividend yields. Utility stocks have long been coveted by investors seeking above-average yield and stable prices. Currently, many high-quality regulated utilities offer bond-like characteristics, but with yields higher than what is available from the 30-year treasury. They have historically been considered very conservative investments, and as such, have often been used to augment a bond portfolio, or even as substitutes for bonds. Utility stocks offer the allure of modest capital appreciation and the potential for modest dividend increases over time, while simultaneously providing a higher degree of safety than most equities.
However, regulated utility stocks have certain characteristics that need to be carefully considered by investors before laying their money down. First and foremost, due primarily to the fact that they are regulated, utilities do offer only very modest growth usually ranging between 3% to 6%. Consequently, there is very little margin for error when attempting to ascertain fair value. Investors need to keep at the forefront of their minds the reality that capital appreciation and dividend income is both a function of and highly correlated to earnings growth. Therefore, if you overpay for utility stocks, you may still receive a modestly increasing dividend each year, but the capital appreciation component of your investment is put in jeopardy.
Historically, PE ratios for quality utility stocks range from approximately 14 to 16 times earnings. These average PE ratios are in line with the PE ratios of the average company. Furthermore, because of the stability and predictability of their earnings and earnings growth rates, utility stocks generally command PE ratios that are equal to other equities possessing faster growth rates. However, because of their low potential for growth, there is actually less margin of error regarding valuation. On the other hand, if purchased at sound valuations, utility stocks can provide an above-average stable source of income, and modest capital appreciation that together provide a reasonable hedge against inflation.
The following table summarizes five fairly valued Central United States Utilities with above-average dividend yields that appear to be attractively valued, and lists them in order of dividend yield highest to lowest. From left to right, the table shows the company's stock symbol and name. Next, two valuation metrics are listed side-by-side, the current PE ratio followed by the historical normal PE ratio for perspective. Then the five-year estimated earnings per share growth is shown next to each company's historical EPS growth providing a perspective of the past versus the future growth potential of each company. The final three columns show the current dividend yield, the company sector and its market cap.
A Closer Look at the Past and the Future Potential
Since a picture is worth 1,000 words, we'll take a closer look at the past performance and future potential of each of our five candidates through the lens of F.A.S.T. Graphs™.
Earnings Determine Market Price: The following earnings and price correlated historical graphs clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings. The historical normal PE ratio line (dark blue line with*) depicts a PE ratio that the market has historically applied.
The orange True Worth™ line and the blue normal PE ratio line provide perspectives on valuation. The orange line reflects the fair value of each company's earnings relative to its growth rate achievement, and the blue line reflects how the market has traditionally valued the company's stock relative to its fair value. The blue line represents a trimmed historical normal PE ratio (the highest and lowest PEs are trimmed). These lines should be viewed as barometers or aids for ascertaining sound buy, sell or hold decisions. Rather than seen as absolutes, they should be seen as guides to better thinking.
Integrys Energy Group is a diversified energy holding company with regulated electric and natural gas utility operations (serving customers in Illinois, Michigan, Minnesota, and Wisconsin), nonregulated energy operations, and an approximate 34% equity ownership interest in American Transmission Company (a federally regulated electric transmission company operating in Wisconsin, Michigan, Minnesota, and Illinois).
The consensus of 6 leading analysts reporting to Capital IQ forecast Integrys Energy Group, Inc.'s long-term earnings growth at 5%. Integrys Energy Group, Inc. has medium long-term debt at 38% of capital. Integrys Energy Group, Inc. is currently trading at a P/E of 17.3, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Integrys Energy Group, Inc.'s True Worth™ valuation would be $67.19 at the end of 2017, which would be a 8.8% annual rate of return from the current price.
DTE Energy is a Detroit-based diversified energy company involved in the development and management of energy-related businesses and services nationwide. Its operating units include Detroit Edison, an electric utility serving 2.1 million customers in Southeastern Michigan, MichCon, a natural gas utility serving 1.2 million customers in Michigan and other non-utility, energy businesses focused on power and industrial projects, coal and gas midstream, unconventional gas production and energy trading.
The consensus of 11 leading analysts reporting to Capital IQ forecast DTE Energy Co.'s long-term earnings growth at 3.9%. DTE Energy Co. has high long-term debt at 50% of capital. DTE Energy Co. is currently trading at a P/E of 14.7, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, DTE Energy Co.'s True Worth™ valuation would be $69.61 at the end of 2017, which would be a 8% annual rate of return from the current price.
Wisconsin Energy Corporation , based in Milwaukee, is one of the nation's premier energy companies, serving more than 1.1 million electric customers in Wisconsin and Michigan's Upper Peninsula and more than 1 million natural gas customers in Wisconsin. The company's principal utility is We Energies. The company's other major subsidiary, We Power, designs, builds and owns electric generating plants.
The consensus of 12 leading analysts reporting to Capital IQ forecast Wisconsin Energy Corp.'s long-term earnings growth at 5%. Wisconsin Energy Corp. has high long-term debt at 54% of capital. Wisconsin Energy Corp. is currently trading at a P/E of 15.4, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Wisconsin Energy Corp.'s True Worth™ valuation would be $43.39 at the end of 2017, which would be a 7.3% annual rate of return from the current price.
MGE Energy is a public utility holding company. Its principal subsidiary, Madison Gas and Electric (MGE), generates and distributes electricity to 139,000 customers in Dane County, Wis., and purchases and distributes natural gas to 144,000 customers in seven south-central and western Wisconsin counties. MGE's roots in the Madison area date back more than 150 years.
The consensus of 1 leading analysts reporting to Capital IQ forecast MGE Energy Inc.'s long-term earnings growth at 4%. MGE Energy Inc. has medium long-term debt at 40% of capital. MGE Energy Inc. is currently trading at a P/E of 16.8, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, MGE Energy Inc.'s True Worth™ valuation would be $49.66 at the end of 2017, which would be a 5.3% annual rate of return from the current price.
OGE Energy is the parent company of Oklahoma Gas and Electric Company (OG&E), a regulated electric utility serving more than 789,000 customers in a service territory spanning 30,000 square miles in Oklahoma and western Arkansas, and of OGE Enogex Holdings LLC, a natural gas pipeline business with principal operations in Oklahoma.
The consensus of 7 leading analysts reporting to Capital IQ forecast OGE Energy Corp.'s long-term earnings growth at 6%. OGE Energy Corp. has medium long-term debt at 49% of capital. OGE Energy Corp. is currently trading at a P/E of 15, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, OGE Energy Corp.'s True Worth™ valuation would be $70.07 at the end of 2017, which would be a 7.8% annual rate of return from the current price.
Summary and Conclusions
The five Central United States regulated utilities covered in this article represent examples of companies providing stable and reasonably predictable dividends. Integrys Energy Group has recently suffered a regulatory setback, but offers the highest yield of the group. DTE Energy Co. has recently been getting regulatory relief and although it lacks growth, it does offer a higher-than-average yield. Wisconsin Energy Corp. offers the strongest historical earnings growth and recently raised its dividend and announced a stock repurchase plan. MGE Energy Inc. offers an attractive opportunity in renewable energy and the Madison Wisconsin market offers above-average economic conditions indicating continued stability. OGE Energy Corp. offers the lowest yield of the group, but their board of directors recently authorized a higher-than-expected dividend increase.
When reviewing the earnings and price correlated graphs on each of these five Central United States regulated utilities, it becomes crystal clear how relevant the earnings and price relationship is. Although the price earnings ratios of these companies stay within a reasonable range of normal, a review of long-term performance results show that the appreciation component closely matches each company's earnings growth rate. Consequently, it should be obvious that even though utilities can be a very conservative way to generate returns that are better than available from bonds, valuation risk needs to be given very careful consideration. However, when bought at appropriate valuations, regulated utilities can provide a great prescription to a good night's sleep.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.