The Top 10 Utility Stocks For 2016 And Beyond

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Includes: AEP, ATO, AVA, BKH, CMS, CNP, D, DTE, DUK, ED, ES, LNT, MDU, NEE, NJR, NWE, OGE, PPL, SCG, SJI, SO, SR, SRE, STR, SWX, VVC, WEC, WGL, WR, XEL, XLU
by: Eric Landis
Summary

With the Fed rate hike now out of the way, it seems like a good time for a review of the utility sector.

Focusing on high quality companies that are trading at fair valuations can help mitigate the risk of rising rates.

This article presents an updated and expanded watch list of 30 of the top utility stocks in the market, and highlights the Top 10 for dividend growth and income.

Series Overview

It's been six months since the initial Top 10 Utilities For Dividend Growth And Income was published, and with the year coming to a close, I thought this would be a good time to update the numbers and put out a new list of the top stocks as we approach 2016.

Looking back since the article was published in June, the utility sector has been on a bit of a roller-coaster ride, with shares trading up and down a few times before settling in with a slight gain here in the last week.

XLU Chart

XLU data by YCharts

The top ten companies selected in the article haven't been spared from the volatility, as there have been plenty of ups and downs for these companies as well. First of all, here is a look back at the ten that were selected in the June article, and their respective dividend yields and projected 5YR growth of yields at that time.

Below I have included the share prices of each company at the time of publishing, and the capital returns to date. For comparison's sake, I have included the Utilities Select SPDR ETF (NYSEARCA:XLU) returns over the same time frame. Keep in mind these returns are capital gains only, and don't take into account dividends received during the period. Considering these stocks had an average yield of 4.16% at the time of publishing, compared with a roughly 3.5% yield from XLU, the out-performance would have been even greater than what is shown.

It's interesting to note that the companies that were considered below "fair value" back in June have generally outperformed (with the exception of SJI) those that were above "fair value" over the last 6 months. This shouldn't be a surprise, but it is a nice confirmation that valuation matters when choosing investments, especially with slower growth companies like the utilities.

Dividend Increases & Added Names

With the main driving force behind these rankings being future income potential, dividend growth is a central component of that projection. The companies on the list haven't disappointed, as there have been ten announced increases since the article was published.

Date Name Ticker Previous Quarterly Rate New Quarterly Rate Sequential Increase Year Ago Dividend Rate YOY Increase Forward Dividend Yield Announcement Link
6/26/2015 DTE Energy Co DTE $0.6900 $0.7300 5.80% $0.6900 5.80% 3.65% LINK
7/7/2015 Duke Energy Corp DUK $0.7950 $0.8250 3.77% $0.7950 3.77% 4.68% LINK
9/1/2015 New Jersey Resources Corp NJR $0.2250 $0.2400 6.67% $0.2250 6.67% 3.16% LINK
9/30/2015 OGE Energy Corp. OGE $0.2500 $0.2750 10.00% $0.2500 10.00% 4.31% LINK
10/20/2015 American Electric Power Company Inc AEP $0.5300 $0.5600 5.66% $0.5300 5.66% 3.90% LINK
11/4/2015 Atmos Energy Corporation ATO $0.3900 $0.4200 7.69% $0.3900 7.69% 2.66% LINK
11/5/2015 Vectren Corp VVC $0.3800 $0.4000 5.26% $0.3800 5.26% 3.83% LINK
11/12/2015 MDU Resources Group Inc MDU $0.1825 $0.1875 2.74% $0.1825 2.74% 4.48% LINK
11/23/2015 South Jersey Industries Inc SJI $0.2513 $0.2638 4.98% $0.2513 4.98% 4.49% LINK
12/3/2015 WEC Energy Group Inc WEC $0.4575 $0.4950 8.20% $0.4225 17.16% 3.86% LINK
12/17/2015 Dominion Resources, Inc. D $0.6475 $0.7000 8.11% $0.6475 8.11% 4.15% LINK
Average: 6.26% 3.92%

The ten announced increases have averaged an impressive 6.26% and the companies that announced them are now providing an attractive forward yield of nearly 4%. For as much as utilities are looked down on as "widow and orphan" stocks, these are producing some pretty healthy dividend increases.

Watch List Additions

As mentioned above, I have expanded the watch list from 25 to 30 companies with this update. The five new additions to the list are: CenterPoint Energy, Inc., Laclede Group, PPL Corp., Southwest Gas Corporation and WGL Holdings Inc. The companies were either recommendations made during the comment thread from the initial article or by my further screening of the CCC List.

In addition to the new names on the list, I have also added a new column to the spreadsheet to give a general idea of the type of business operations that each company is involved in. This was also done so on the request of a reader.

Finally, I have added a column for the debt/cap for each company to go along with the S&P credit rating. I felt this was an easy add from F.A.S.T. Graphs, and could be a helpful metric for people trying to compare prospective companies.

Here is the updated list of the 30 companies.

Company Ticker Service Type # Years Div. Inc. S&P Credit Rating Debt / Cap Market Cap (B$) 52WK HIGH 52WK LOW % Below 52-week High Share Price
American Electric Power Company Inc (NYSE:AEP) Electric 6 BBB 46% $28.0 $65.38 $52.29 -12.1% $57.45
Avista Corp (NYSE:AVA) Electric/Gas 13 BBB 46% $2.2 $38.34 $29.77 -7.9% $35.32
Atmos Energy Corporation (NYSE:ATO) Gas 32 A- 41% $6.4 $63.76 $50.83 -1.0% $63.14
Black Hills Corp (NYSE:BKH) Electric/Gas 45 BBB 52% $1.9 $55.59 $36.81 -21.9% $43.43
CenterPoint Energy, Inc. (NYSE:CNP) Diversified 10 A- 60% $7.6 $24.38 $16.05 -26.8% $17.84
CMS Energy Corporation (NYSE:CMS) Electric/Gas 9 BBB+ 62% $10.1 $38.65 $31.22 -6.3% $36.20
Dominion Resources, Inc. (NYSE:D) Diversified 12 A- 57% $40.2 $80.89 $64.54 -16.5% $67.54
DTE Energy Co (NYSE:DTE) Diversified 6 BBB+ 48% $14.5 $92.27 $73.23 -13.4% $79.95
Duke Energy Corp (NYSE:DUK) Electric/Gas 10 A- 45% $48.2 $89.97 $65.50 -21.6% $70.50
Consolidated Edison, Inc. (NYSE:ED) Electric/Gas 41 A- 43% $18.8 $72.25 $56.86 -11.1% $64.21
Eversource Energy (NYSE:ES) Electric/Gas 17 A 42% $16.2 $56.83 $44.64 -9.0% $51.71
Alliant Energy Corporation (NYSE:LNT) Electric/Gas 12 A- 48% $6.9 $70.80 $54.27 -10.0% $63.71
Laclede Group Inc (LG) Gas 13 A- 47% $2.5 $59.38 $49.07 -2.5% $57.89
MDU Resources Group Inc (NYSE:MDU) Diversified 25 BBB+ 41% $3.3 $24.58 $16.15 -31.9% $16.74
New Jersey Resources Corp (NYSE:NJR) Diversified 20 N/A 41% $2.6 $33.73 $26.77 -10.0% $30.36
NextEra Energy Inc (NYSE:NEE) Electric 21 A- 48% $47.7 $112.64 $93.74 -8.2% $103.41
NorthWestern Corp (NYSE:NWE) Electric/Gas 11 BBB 50% $2.6 $59.71 $48.44 -8.1% $54.89
OGE Energy Corp. (NYSE:OGE) Electric/Gas 9 A- 43% $5.1 $36.70 $24.15 -30.5% $25.52
PPL Corp (NYSE:PPL) Electric/Gas 14 A- 59% $22.8 $38.14 $29.18 -11.0% $33.94
SCANA Corporation (NYSE:SCG) Electric/Gas 15 BBB+ 51% $8.7 $65.57 $49.89 -6.3% $61.43
South Jersey Industries Inc (NYSE:SJI) Gas 17 BBB+ 41% $1.6 $30.61 $21.24 -23.2% $23.50
Southern Co (NYSE:SO) Electric 15 A 45% $42.1 $53.16 $41.40 -12.5% $46.51
Sempra Energy (NYSE:SRE) Diversified 12 BBB+ 46% $23.9 $116.30 $89.44 -17.5% $95.95
Questar Corporation (NYSE:STR) Gas 36 A 34% $3.4 $26.44 $18.02 -28.2% $18.99
Southwest Gas Corporation (NYSE:SWX) Gas 9 BBB+ 49% $2.5 $64.20 $50.53 -17.8% $52.79
Vectren Corp (NYSE:VVC) Diversified 55 A- 45% $3.5 $49.47 $37.26 -15.5% $41.81
WEC Energy Group Inc (NYSE:WEC) Electric/Gas 12 A- 46% $16.2 $58.01 $44.93 -11.6% $51.26
WGL Holdings Inc (NYSE:WGL) Gas 39 A+ 36% $3.1 $63.81 $50.89 -1.0% $63.18
Westar Energy Inc (NYSE:WR) Electric 11 BBB+ 43% $6.0 $44.03 $33.88 -4.5% $42.04
Xcel Energy Inc (NYSE:XEL) Electric/Gas 12 A- 53% $18.5 $38.35 $31.76 -5.1% $36.40

Looking down the list, there are several stocks that have been hit hard this year, as 7 of the 30 are off more than 20% from 52-week highs, with MDU Resources the hardest hit at -31.9%. On the other end of the spectrum, 5 companies are within 5.1% of their 52-week highs, with Avista Corp and WGL Holdings within 1% of that mark.

Historical Numbers & Analyst Estimates

The first spreadsheet to look at is the historical growth information and current year estimates for each stock. This information was gathered from the U.S. Dividend Champions List, F.A.S.T. Graphs and Yahoo Finance.

I have updated the spreadsheet with the analyst' 2016 earnings estimates for each company, and with all of the currently declared dividend rates. The payout ratio is calculated based on the 2016 EPS estimates and an annualized dividend based on the currently declared rate.

The "Fair Value" PE is a number I derived by looking at each company over different time periods on F.A.S.T. Graphs. This number is then compared with the 2016 estimated PE to calculate a Delta number. A positive delta means the stock is "overvalued", while a negative number means the stock is trading below "fair value".

A side effect of these valuation levels are the corresponding yields that the high or low share prices produce. This is readily apparent when looking at the 5 companies shaded red, as they are all producing dividend yields below 3.2%.

On the other hand, 6 of the 7 companies currently trading below "fair value" are yielding better than 4%. However, current yield doesn't tell the whole picture of income potential for an investment as it ignores growth rate. With the next section, we will combine the current yields with expected growth rates to see what income potential exists for each company.

Income Projections

With this spreadsheet, I have added the 5YR projected growth rates from analysts, as well as guidance for EPS growth from the respective companies. This guidance, along with targeted payout ratio levels for the companies, was determined from searching through conference call transcripts (graciously provided here on Seeking Alpha) and investor presentations on company websites.

These growth and target numbers were then used in combination with historical dividend growth trends to come up with my projected dividend growth rates going forward. Finally, the EPS and dividend growth rates, "fair value" deltas and current dividend yields were used to project the 5YR yield on cost [YOC], 5YR YOC with dividends reinvested, and 5YR Total Returns for each company.

Here you can see there are some attractive opportunities for both income and total returns, as there are currently 10 stocks with projected 9%+ annualized returns. Many of these companies are also the ones with the highest projected incomes, and we will take a look at those next.

The Top Ten

With the math and spreadsheets out of the way, now we can move on to selecting the top ten. As with previous articles, this top ten was selected primarily based on the projected 5YR yield on cost numbers, with secondary considerations given to current yield and the projected YOC with reinvestment of dividends.

These stocks are selected based on the closing prices and declared dividend rates as of December 17, 2015.

OGE Energy Corp. ranked #4 on the initial top ten list, and it hasn't disappointed in the income department, as it announced a 10% boost to the dividend in September. Unfortunately for shareholders, the market has been more focused on its exposure to the energy market than on its dividend, as shares have fallen 12% since the June article.

The income outlook for the company remains strong, as management reiterated its intentions to grow the dividend at a 10% annual rate through 2019. With a payout ratio of just 56%, this appears to be a reasonable and attainable growth rate going forward.

OGE has a nice current yield of 4.3%, but what is most attractive for investors is the double digit growth rate of the dividend. The company is also attractive on a valuation basis as it currently trades below its 10YR Normal P/E levels. This combination of a higher yield and low valuation provides a projected 5YR annualized return of 11.4%, good enough for #3 on the list.

CenterPoint Energy, Inc. is one of the new companies on the watch list, and it immediately debuts at #2 in the rankings for 2016. The company is a Dividend Contender with a 10 year streak of dividend increases. The company's high payout ratio leads to the highest current yield in the group, at 5.55%. This high overall payout ratio is enabled by cash flow from secondary sources in the mid-stream sector, but focusing strictly on the utility portion of its business leads to a more reasonable payout of 60-70% of earnings.

Management is more optimistic about growth prospects than analysts, are they are providing guidance of 4-6% annual growth compared with just 2.5% from estimates. Personally, I would trend more towards analyst expectation than management, as the company hasn't shown the ability in recent history to grow at those rates and has grown earnings at just a 1.4% annual rate over the last 5 years. CenterPoint does have an attractive "A-" credit rating from S&P, but also has a dividend cut on its track record, with several years of decreasing or frozen dividends in the early 2000's.

I don't see CenterPoint as a sleep-well-at-night type of investment compared to some of the other names on this list, but it is an attractive option for those looking to boost their income. If management can pull off the 4-6% growth rate going forward, this could end up being a very good entry point for long-term investors.

Dominion Resources ranked #2 on the original list, and remains near the top at the #3 spot with this update. Dominion announced its intentions for an 8.1% raise with the next dividend declaration, which boosts the forward yield to 4.15%. Even better, the company reiterated its intent to maintain a 70-75% payout ratio going forward and maintained guidance of an 8% growth rate in the dividend through the end of the decade.

Dominion looks to be a beneficiary of the growth in gas production coming from the Marcellus and Utica as it works to expand its mid-stream capabilities and continues with construction on the Cove Point LNG export facility.

Shares are currently a bit on the expensive side compared to historical levels, but with a forward yield over 4% and a relatively high EPS growth rate of 6.5% expected, I believe shares are still attractive at current prices.

Duke Energy drops one spot in the rankings to #4 with this update. As highlighted above, Duke announced a 3.77% boost to the dividend in July. This increase was higher than what it has seen over the last 5 years, but lower than what I had been projecting for growth going forward. With the payout ratio currently on the high end of guidance, I have tempered my expectations for dividend growth, dropping my projected growth rate from 5% to 4%. However, with a current yield of nearly 4.7%, this is still an attractive growth rate for income investors, and is well above the rate of inflation.

In other news, Duke announced in October that it will be spending $4.9B to acquire Piedmont Natural Gas (NYSE:PNY) in a move that should help to diversify the business and lead to growth opportunities for the company. This move took out another DGI favorite in PNY, and while pricey, should be a positive development for Duke investors.

With Duke currently trading more than 20% off of 52-week highs, shares are now below fair value. Between a healthy yield and mid-single digits growth, long-term investors could see 8-10% total annual returns going forward.

With a nearly 10% rise in share price since the original article, Southern Company has now moved down from the top spot to #5 on this list. That shouldn't diminish investors view of the company however, as it remains one of the most consistent performers in the sector.

Similar to Duke, Southern also announced a significant acquisition in 2015, as it announced a $12B transaction to acquire AGL Resources (NYSE:GAS) in August. This move is expected to close in 2016 and be immediately accretive to Southern's earnings. Additionally, management has indicated it could lead to enhanced earnings and dividends growth going forward, which led me to boost my expectations for dividend rate from 3% to 3.5% with this update.

Shares appear to be trading within normal historical levels, and with a current yield of around 4.7%, Southern remains an attractive option for income investors.

PPL Corporation is new to the watch list, and debuts at #6 in the rankings. The company is a Dividend Contender, with a 14-year streak of dividend increases, during which it has grown the payout at a 6.1% annualized rate over the last decade. The growth rate has slowed in recent years however, as it has shown just 1.5% annualized dividend growth over the last 5 years.

Management has given expectations of 6% earnings growth going forward, and analysts are expecting growth of 4.8%, both of which are significantly higher than what the company has produced in recent years. I am projecting 4% annual dividend growth over the next five years, but it remains to be seen if PPL can deliver that kind of growth.

PPL is currently trading near fair value and this appears to be a reasonable entry point for purchase. The company isn't as high on my personal radar as some of the others on the list, but if it can hit the targets provided by management, would be a nice opportunity for investors.

American Electric Power Company moves into the #7 spot in the rankings after announcing a 5.66% increase to the dividend in October. With an increase above my previous expected growth rate, and a payout ratio at the low end of guidance, I moved my expectations for future dividend growth up from 5% to 6.5%. So even though the current yield was relatively unchanged since the June article, the higher growth expectations were enough to move it up the rankings.

AEP has been a fairly consistent performer over the years, and has produced 4% annualized earnings growth over the last decade. This is a bit below management and analyst numbers however, so it remains to be seen if those higher expectations can be met. At BBB, the company also has a bit lower credit rating than others on the list, which is could be a consideration with potentially higher interest rates on the horizon.

While prices are roughly 14% below 52-week highs, shares are still trading a bit above my "fair value" PE target of 14, and may not be as attractive as some other companies on the list. However, with a 4% yield and a mid-single digit growth rate, it still appears to be a stock worth considering.

At #8, MDU Resources Group is another new entry on the top ten list. With its November announcement of a 2.7% dividend boost, MDU has also become a new member of the Dividend Champions list for having 25 years of increasing payouts.

As a diversified company, MDU's previously held Fidelity Exploration arm was hit hard with the sharp fall in crude prices. This led to a sharp drop in earnings and uncertainty for investors. This picture was cleared up a bit in November however, as the company announced the intended sale of the business, which should lead to $450M in proceeds and tax benefits that will be used to pay down debt. Removing this volatile portion of the business from the fold should provide a more stable outlook going forward, and with analysts currently projecting for 6.7% earnings growth, could lead to a higher dividend growth rate as well.

The company is a bit difficult to value on earnings alone due to the changing nature of the business. However, looking at the dividend yield, MDU is currently trading at the highest yield since the recession.

MDU Chart

MDU data by YCharts

MDU isn't often talked about as a dividend growth idea, but with a 25-year streak of increasing payouts and a relatively high growth rate in comparison to some others on the list, I feel it is a worthy candidate.

WEC Energy Group, formerly known as Wisconsin Energy, remains in the #9 slot on the list. Since the last article, Wisconsin Energy completed its acquisition/merger with Integrys that is expected to enhance the long-term growth prospects for the company.

On December 3, WEC announced an 8.2% increase to the dividend, which now puts it at the mid-point of the targeted 65-70% payout ratio based on 2016 earnings. This has caused me to slightly lower my dividend growth projections from 7% to 6.5% going forward, despite a higher estimated earnings growth rate, as I expect dividend growth to mirror earnings growth from now on.

Shares are trading above "fair value" levels and may not be as attractive as some other companies on the list. However, with a nearly 4% yield, a solid track record, and improved outlook for earnings growth going forward, I will be looking to add to my position on any significant pullback.

The final company on the top ten list is Questar Corporation , which makes its first appearance on the list. Questar is a Dividend Champion, with a 36-year streak of dividend increases. Questar makes the list despite me cutting my dividend growth expectations as I moved more towards analyst expectations of 3.5% growth rather than managements guidance of 4-6% growth, primarily due to the fact that the company has seen just low single-digit growth in recent years.

Questar moved into the rankings primarily due to valuation, as the company is trading nearly 30% below 52-week highs and now provides a yield of over 4.4%. With shares now well below "normal P/E" levels, it could provide some potential for capital returns on top of the attractive dividend. With an "A" credit rating and a 36-year track record of dividend growth, this appears to be a nice investment opportunity in the company.

Conclusion

As volatility appears to once again be returning to the market and we near year's end, I felt it was a great time to update the list and take a stab and finding the best income opportunities in the sector. While the fears of further rate hikes cloud the picture and add to the volatility, I expect the financially strong in the sector to fare well and to continue producing increasing dividends. I believe this top ten provides a nice shopping list of high-yield stalwarts as well as some higher growth options for those looking for potential capital gains.

Personally, I am waiting for my IRA contributions to hit the account, and am currently leaning towards adding to my positions in either Dominion Resources or MDU Resources.

Happy Holidays to all, and best wishes in the new year!

Disclosure: I am/we are long D, MDU, WEC, XEL. 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.

Additional disclosure: I am a Civil Engineer by trade and am not a professional investment adviser or financial analyst. This article is not an endorsement for the stocks mentioned. Please perform your own due diligence before you decide to trade any securities or other products.