Duke Offers A Solid Dividend At A Great Price (NYSE:DUK)

Summary

Management predicts dividend growth of at least 4%.
Earning support the current dividend, and earnings growth should more than cover a growing dividend.
At the current market price of just over $75, DUK is a great opportunity for dividend growth investors.

At the current market price of just over $75, the dividend and projected dividend growth more than justifies the price. I think Duke Energy (NYSE:DUK) has the potential to be a great opportunity for dividend growth investors.

What did I think of DUK last time?

Back on July 18th just after Duke had raised its dividend, I wrote about why it was a good buy. I liked that Duke had continued to rebuild its earnings and revenues after it sold off the Latin American business. I liked that it had just announced an increase in its well supported dividend. And the share price was then below what I calculated for a buy price based on the current dividend and its likely future growth.

Below is the calculation I did to determine a good buy price for DUK shares. I used the just declared dividend to project the next 12 months of dividend payments, $3.56. Based on management saying they wanted to increase dividends by 4%-6% each year till 2021, management projections of earnings growth, and the latest dividend increase of 4.1%, I estimated that the dividend could be grown by about 4.5%. Based on the current yield, I used a terminal growth rate of 2%. Because earnings and revenues were declining I wanted a 10% discount to the NPV of the dividends which made my buy price anything under $84.

What new information do we have now?

As most people know interest rates have been rising lately and the Federal Reserve has plans to raise the over-night rate several times this year. In his first time testifying to Congress, Fed Chairman Powell’s testimony has pushed rates higher today. Among other stocks, this has pushed the share price of utilities down. Depending on a number of factors, I think this price decrease could represent an opportunity. One thing I will look at is if Duke is handling its debt and interest costs well.

The first bit of news to look at is the recently released earnings report and slide presentation.

The slide above is the highlights from 2017. I like that DUK hit near the high end of its guidance. I also like seeing numbers for 2018. The middle of the range is $4.70 is about 3.3% above 2017, so it’s a good thing that DUK tends to hit the higher end. I also like that management has extended its prediction of 4%-6% EPS growth to 2022.

This slide reiterates management’s predictions on EPS and dividend growth. I like it when management tells me what their expectations of growth are, because that helps me figure out a good price for the stock.

I always like to see what factors lead to one year’s earnings versus the prior year. The slide above provides a comparison between earning in 2016 and 2017. I like the 5% growth in earnings from providing utilities. $0.25 is a pretty good reduction in costs, although I expect it can’t continue at that level for long. It’s interesting to note that the decrease in earnings because of the sale of the Latin American assets is 3 times the reduction in earnings from last year. That tells me that DUK should grow from here fairly easily.

The slide above provides some detail on the 2018 guidance, specifically on how the company expects tax reform to impact its growth estimates. Management has said it expects growth of earnings to be between 4% and 6% each year, with 5% being the middle. So assuming the company hits the middle of that range, the mid-point of EPS will be $4.83 a share. But that is before taking into account the effects of tax reform and the decision to raise more equity for acquisitions and development. It makes a lot of sense to me that the costs of tax reform outweighs the benefits as I would expect much of the increase in earnings would be refunded to the customer. And at the holding company level, the lower tax rate lowers the value of its tax shield. This should be a short term drag, so I am glad that management reaffirms its longer range guidance and expects to be back on track by 2019.

One thing I always like to see is a clear statement from management as to how they set the dividend. The slide above shows what Duke management views as a commitment on the dividend. Because I determine a price I want to pay for a stock based on its predicted dividend payments, setting a range for the payout ratio gives me a way to verify that my dividend projections match up with management policy.

The slide above shows the details in what Duke expects to change in 2018 from 2017. When I first looked at it, I thought it was expecting a lot to get $0.12 a share from more favorable weather. However, since unfavorable weather reduced earnings in 2017 by $0.26, it doesn’t seem too much. That would still see the weather dropping earnings by about $0.14 because it was less favorable than average. I see management’s guidance for 2018 as a good setup for growth, but in 2018 and beyond.

On the debt management front, because of tax reform and its negative impact on utility earnings, Moody’s recently downgraded its outlook on Duke to negative. This is part of the reason why management decided to use more equity to fund growth, and why it plans to sell some $2 billion of equity in 2018.

What does Simply Wall St say?

Simply Wall St. provides very useful visualizations of data and an additional check on what might be expected in terms of growth from Duke. Based on data from S&P Capital IQ, I see that analysts expect earnings to grow about 7% and revenue to grow 3.7%. Based on what the analysts seem to expect, I see no reason to doubt management guidance. While 7% earnings growth might not be high growth, I think it’s pretty good for a utility and is attractive to me.

What’s a good price?

To figure out a good price, I do a DDM calculation using my Excel® based DDM calculator (pictured below, you can see the web-based calculator I based it on here and read a discussion on how the formulas were developed here). I also found this discussion of DDM, and note that in the article the author uses a discount rate of 5%.

Looking at the David Fish’s CCC List(which contains a data on companies that have raised their dividend each year for 5 or more years) I see that Duke has been growing its dividend every year since 2005. For the next 12 months I estimate that one would get two more dividend payments of $0.89 and then 2 payments at $0.92 for a total of $$3.62. Based on what management has said about the dividend policy and what it says is the rate of growth of earnings, I estimate that Duke should be able to grow the dividend 4% over the next 5 years (this is a bit lower than what I estimated last time). Given the current yield I will use 2% for the terminal dividend growth rate.

Using those parameters, I calculate that the NPV of the predicted dividend stream is $91.78. Due to continued pressure on earnings and revenue from the sale of the Latin American operations and due to the impact of tax reform, I will keep the 10% discount I used last time, which will give me a buy price of $83.

I see that the 4 year average yield is 4.2%. Using that with the current dividend payment of $3.56 to calculate a price, I get $84.76. I think my buy price is also reasonable based on that.

At anything under $83, the current market price could be a great opportunity for a dividend growth investor to pick up shares in a solid dividend paying company. The ~4.7%yield is also pretty attractive for a utility company.

As the screen shot from my broker shows, I used the nice low price to pick up just over 60 shares of DUK at a very good price.

Can options help?

For some quick cash, an investor could pick up around a $1 a share ($100 for a contract) writing a put contract that expires on March 16 ^th at a strike price of $75. $100 is a nice payment for holding $7500 in cash for 16 days even if you don’t get assigned the shares. And picking up the shares at $75 is an even better deal than the market is currently offering.

What to watch for going forward?

Going forward, Duke is planning to sell some $2 billion in shares, so I would want to keep an eye on how much they get for them. They are projecting a nickel a share dilution for this sale, so I want to see that they hit that.

In the next quarter, I want to see at least 3.5% growth from the same period last year, so I can be sure they will come close to the guidance they have given for the full year.

Conclusion

Duke is a good solid utility. There is none of the drama with nuclear plants that some other utilities I like are seeing. I think selling off the Latin American assets was a good move, I expect to see the numbers this year to back that up. Given where management has said the dividend will go, and what they project for earnings, I think the current market price just over $75 offers the potential for a great bargain to dividend growth investors. I know I increased my holdings and am very happy with the income DUK shares provide me.

Note: I hope you all got something out of this article. I do appreciate the time you took reading it. If you are one of those who follow me here, I appreciate it; if you'd like to include yourself amongst those individuals, please hit the "Follow" button next to my name as well as following other contributors whose work you enjoy. As always, please leave any feedback and questions you may have in the comments below.

Simply Wall St provides me free access to its premium paid service so I can use data they provide to help support my investment thesis. I use their data and graphs when it supports my case. Much of the data that appears in their graphs and charts comes from Capital S&P IQ.

Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. The price I call fair valued is not a prediction of future price but only the price at which I consider the stock to be of value for its dividends.

This article was written by

PendragonY

12.52K Followers

PendragonY is a software engineer and has been developing applications for various industries for over 30 years. He has been managing his own investments for 40+ years. Formerly a value investor, he switched over to a more income based approach after the 2008 financial crisis.

PendragonY contributes to the investing group High Dividend Opportunities led by Rida Morwa and a team of other top Seeking Alpha income investing analysts. The service focuses on sustainable income through a variety of high yield investments with a targeted safe +9% yield. Features include: model portfolio with buy/sell alerts, preferred and baby bond portfolios for more conservative investors, vibrant and active chat with access to the service’s leaders, dividend and portfolio trackers, and regular market updates. The service philosophy focuses on community, education, and the belief that nobody should invest alone. Learn More.

Analyst’s Disclosure: I am/we are long DUK. 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.

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