Utilities have pulled back sharply recently, most likely in response to the small rise in long-term interest rates as well as possibly serving as a source of funds for purchases of more cyclical stocks. In a rising interest-rate environment, utilities, which don't grow rapidly and also are subject to regulation in terms of their ability to raise rates, could fare poorly.
I shared my negative sentiments recently on the sector when I discussed how rising rates might impact certain investments. I also suggested a strategy for how to use growth in dividends rather than focusing on just yield if one is concerned about capital loss. While this generally disfavors holding utilities, it's still possible to focus on those utilities with the most ability to raise dividends.
There are 82 utilities in the Russell 3000, and only 30 of them yield 4% or more, reflecting how well the sector has done in recent years as income investors have migrated into the sector. Only 6 offer yields above 5%. I recall a couple of years ago calling out how attractive the sector was, with many companies offering more than 5% yield. But, with rather stingy growth in dividends and a 14% rise in XLU over the past two years, those yields are a lot lower.
So, with the goal of finding utilities that might offer a reasonable yield but also a better-than-average chance of an increased dividend, I set up the following screen using Baseline:
- Current Yield > 3% (62 of 82)
- Projected 2013 EPS Growth > 4% (37 of 62)
- Payout Ratio < 65% (14 of 37)
- Hikes in Past 5 Years = 5 (11 of 14)
Here are the stocks that made the cut:
I sorted the list by yield - four of the names do offer 4% or more. I also color-coded several different columns to help dig in a little better.
- Net Debt to Capital: Red above 70%, Green below 50%
- Dividend Yield vs. 5-year Average: Red below 80%, Green above 120%
- 2013 EPS Growth: Green for double-digit
- Payout ratio: Red 60-65%, Green <55%
- 5-Year Dividend Growth: Red below 5%, Green >10%
- 5-year EPS Growth: Red below 0, Green > 5%
- PE vs. 10-year median: Red >120%
CMS Energy (NYSE:CMS) has been growing. While it has above-average debt and a higher payout ratio, if it can sustain the growth, it could continue to boost the dividend.
Northwestern (NYSE:NWE) is one that I have called out in the past and like. It used to yield too much in my view, but it has been discovered. It trades at an average PE over the past decade.
WGL Holdings (NYSE:WGL) has a strong balance sheet and is growing now after stalling in recent years.
XCel (NYSE:XEL) is another one that I like. The dividend growth has been on the slower side, though.
Centerpoint Energy (NYSE:CNP) has more debt than the peers and has seen its yield drop compared to its history. This one seems to have the most "red marks".
Northeast Utilities (NYSE:NU) has among the higher earnings and dividend growth rates, with no "red marks".
Questar (NYSE:STR) looks expensive by these metrics, but I think Baseline's data is suspect. The company did a spin-off of its E&P company. The company appears capable of boosting its dividend 5% or more per year.
Nextera Energy (NYSE:NEE), formerly Florida P&L, fell out of favor but has done well more recently. It has a nice mix of regulated and unregulated business. The low payout and decent EPS growth are favorable.
Chesapeake Utilities (NYSE:CPK) has a great balance sheet. While it has seen its dividend yield fall, the payout is low and the growth of the earnings strong.
I like South Jersey Industries (NYSE:SJI), which has a strong management team and a good mix of regulated and unregulated business. The regulated business benefits from natural gas displacing propane. The balance sheet here is the only slight negative. For those looking for a "growth Utility with some yield", this one merits a closer look.
MDU Resources (NYSE:MDU) has a strong balance sheet. Earnings are bouncing back but have been weak in recent years. This one has one of the highest PE ratios.
In conclusion, utilities are not likely to fare well in a rising interest rate environment. I believe that other income-oriented investments that are capable of generating some growth in the dividend make more sense. To the extent one wants to remain in the sector, it makes sense to consider the dividend growth potential rather than focusing solely on maximum yield. The screen I ran hopefully gives you some ideas to consider further.