Top 10 Utility Stocks For Dividend Growth And Income

Summary

• It's been sixteen months since I last covered the top dividend growth stocks in the utility sector.
• Rising interest rates and a falling market have contributed to a sell-off of utility stocks, with many reaching bear market territory.
• This article provides an update of my thirty-stock watch list and presents my top ten picks for dividend growth and income.

It's been sixteen months since I presented my list of 2017's Top 10 Utility Stocks For Dividend Growth And Income. A lot has happened during that time, including the inauguration of a new U.S. President, the Bitcoin (BTC-USD) and cryptocurrency craze, all-time market highs, Federal Reserve interest rate hikes, a stock market correction, and the threat of a potential trade war with China.

As you can see in the chart below, the utility sector, as represented by the Utilities Select Sector SPDR ETF (XLU), continued rising along with the overall market throughout most of 2017. However, once interest rates started to rise in late Q4 and into 2018, the utilities dropped, giving up all of their gains from 2017.

They've started to recover a bit the last few months, but are still well below former highs.

SPY data by YCharts

The utility sector was quite expensive when the last update was published, so the fact that it underperformed the overall market isn't all that surprising.

Here was my comment on valuation from the article:

The valuation problem remains today, as just 3 of the 30 companies on the watch list are trading within 10% of my "fair value" target. Even worse, that valuation is being calculated based on 2017 EPS estimates, meaning investors are not only "paying up" at today's prices, but they are also doing so on a forward basis as well.

This isn't to mean the utility sector is completely devoid of opportunity, but my expectations going forward remain guarded.

As shown in the chart above, despite the price premium, the market continued to ignore valuations for utilities for another nine months following that article.

However, the bottoming and reversal of treasury yields in Q3 of 2017 marked an inflection point, and utilities have now dropped 15% from the high.

My picks performed in a similar fashion, as they've increased in share price by just 2.80%, lagging the price return of XLU.

Keep in mind, the selections made were based on future dividend income expectations, not price. Considering all the picks have continued to pay and raise their dividends, and had an attractive average yield of 3.85% at purchase, I'm okay with how they've performed.

The Updated Watch List

I made a couple of changes to the watch list with this update, dropping Avista Corp. (AVA) and SCANA Corp. (SCG), and adding Pinnacle West Capital Corp. (PNW) and ONE Gas Inc. (OGS) as replacements.

Avista is due to be acquired by Canada's Hydro One (OTCPK:HRNNF), while SCANA is mired in problems from its failed nuclear power plant project, which led to its agreement to be acquired by Dominion Energy, Inc. (D).

Both deals are still waiting for final approval by regulators, and in the case of SCANA there is the possibility of the deal not going through. Thus, with the uncertainty surrounding them, I decided to act now to find new replacements for the watch list.

The first replacement, Pinnacle West, is an electric utility based in Phoenix, Arizona. It has a six-year streak of dividend growth, after having frozen the dividend for a few years following the '08/'09 recession.

The second replacement, ONE Gas, is a natural gas utility based in Tulsa, Oklahoma, that provides distribution services to more than 2 million customers in Kansas, Oklahoma, and Texas. The company has raised the dividend on an annual basis since it began trading in 2014 after its spin-off from ONEOK, Inc. (OKE).

Here is the list of companies after the update:

Ticker	Company		# Years Div. Inc.	S&P Credit Rating	Market Cap (B$)	52-Week High	52-Week Low	% Below 52-week High	5-2-2018 Share Price
(AEP)	American Electric Power Company Inc.	Electric	8	A-	$34.1	$78.07	$63.32	-11.4%	$69.19
(ATO)	Atmos Energy Corporation	Gas	34	A	$9.7	$93.56	$76.46	-7.0%	$86.97
(BKH)	Black Hills Corp.	Electric/Gas	47	BBB	$3.1	$72.02	$50.49	-20.2%	$57.48
(CNP)	CenterPoint Energy, Inc.	Diversified	13	A-	$11.0	$30.45	$24.81	-16.4%	$25.46
(CMS)	CMS Energy Corporation	Electric/Gas	11	BBB+	$13.2	$50.85	$40.48	-7.8%	$46.86
(D)	Dominion Energy Inc.	Diversified	15	BBB+	$44.5	$85.30	$63.88	-22.4%	$66.19
(DTE)	DTE Energy Co.	Diversified	9	BBB+	$18.8	$116.74	$97.66	-10.3%	$104.75
(DUK)	Duke Energy Corp.	Electric/Gas	13	A-	$56.0	$91.80	$72.93	-12.9%	$79.98
(ED)	Consolidated Edison, Inc.	Electric/Gas	44	A-	$24.6	$89.70	$73.73	-11.6%	$79.25
(ES)	Eversource Energy	Electric/Gas	20	A+	$18.9	$66.15	$55.93	-9.8%	$59.69
(LNT)	Alliant Energy Corporation	Electric/Gas	15	A-	$9.9	$45.55	$36.84	-5.9%	$42.87
(MDU)	MDU Resources Group Inc.	Diversified	27	BBB+	$5.5	$28.54	$24.29	-1.6%	$28.09
(NJR)	New Jersey Resources Corp.	Diversified	22	N/A	$3.7	$45.45	$35.55	-8.3%	$41.70
(NEE)	NextEra Energy Inc.	Electric	24	A-	$77.1	$165.15	$133.07	-1.0%	$163.45
(NWE)	NorthWestern Corp.	Electric/Gas	14	BBB	$2.7	$64.47	$50.01	-15.0%	$54.79
(OGE)	OGE Energy Corp.	Electric/Gas	11	A-	$6.6	$37.32	$29.59	-11.3%	$33.10
(OGS)	ONE Gas Inc.	Gas	5	A	$3.8	$79.51	$62.20	-8.7%	$72.63
(PNW)	Pinnacle West Capital Corporation	Electric/Gas	6	A-	$8.9	$92.48	$73.81	-14.1%	$79.42
(POR)	Portland General Electric Company	Electric	12	BBB	$3.8	$50.11	$39.02	-16.0%	$42.08
(PPL)	PPL Corp.	Electric/Gas	17	A-	$19.9	$40.20	$27.08	-28.6%	$28.69
(SJI)	South Jersey Industries Inc.	Gas	19	BBB+	$2.6	$37.61	$25.96	-17.7%	$30.96
(SO)	Southern Company	Electric	17	A-	$46.6	$53.51	$42.38	-13.6%	$46.25
(SR)	Spire Inc.	Gas	15	A-	$3.5	$82.85	$60.08	-12.9%	$72.15
(SRE)	Sempra Energy	Diversified	15	BBB+	$29.3	$122.97	$100.63	-9.6%	$111.16
(SWX)	Southwest Gas Holdings Inc.	Gas	12	BBB+	$3.5	$86.87	$62.53	-15.7%	$73.23
(UGI)	UGI Corp.	Diversified	30	N/A	$8.3	$52.00	$42.51	-7.2%	$48.26
(VVC)	Vectren Corp.	Diversified	58	A-	$5.8	$70.73	$57.48	-0.7%	$70.22
(WEC)	WEC Energy Group Inc.	Electric/Gas	15	A-	$20.3	$70.09	$58.92	-8.1%	$64.38
(WGL)	WGL Holdings Inc.	Gas	41	A	$4.4	$86.89	$80.91	-1.2%	$85.84
(XEL)	Xcel Energy Inc.	Electric/Gas	15	A-	$23.7	$52.22	$41.51	-10.9%	$46.54

Click to enlarge

The recent sector sell-off is apparent when looking at the comparison to 52-week highs, as just four of the thirty utilities - MDU Resources Group, NextEra Energy, Vectren Corp., and WGL Holdings - are trading within 5% of that number.

Two of those four, Vectren and WGL Holdings, will also likely be falling off the list in the near future, as WGL Holdings is being acquired by AltaGas (OTCPK:ATGFF) and Vectren is being acquired by CenterPoint Energy.

Meanwhile, seventeen of the thirty companies are in correction mode, and three companies - Black Hills Corp., Dominion Energy, and PPL Corp. - are trading more than 20% below recent highs.

Of course, price relation to 52-week levels is fairly meaningless, as that doesn't necessarily equate to a stock trading at a good value. In the next part, we take a look at relative valuation compared to historical numbers and try to find some deals on the list.

Historical Numbers and Analyst Estimates

I have updated the spreadsheet with 2018 EPS estimates from F.A.S.T. Graphs and Yahoo Finance, and will now look at how these valuations compare with historical levels.

The historical "Fair Value" P/E was found by looking at various time frames on F.A.S.T. Graphs to determine what earnings multiple each company typically trades at. This is then compared with the 2018 P/E from analyst estimates to calculate the "Delta P/E" to show a relative valuation.

In this case, a negative number is good, as that means shares are currently trading below the fair value number.

I've also updated the historical dividend growth information for each company from David Fish's U.S. Dividend Champions spreadsheet to show how the various companies compare to each other by dividend growth rates.

I also find this information useful as a quick way to see how dividend growth rates have progressed over time, and if current growth rates are higher or lower than the recent trends.

Here are the updated numbers:

The current numbers look much better than those calculated in 2017, when just three of the thirty companies were trading within 10% of the fair value mark.

Half of the watch list is now within the 10% mark, and there are nine companies trading below the fair value target.

The deepest value is Dominion Energy, which is actually 13.6% below my fair value target. Meanwhile, the two utilities being acquired in mergers have the most overpriced shares, with Vectren at 36.4% and WGL Holdings at 31.7% above fair value.

Income and Total Return Projections

Current yield is an important metric for investors, but its importance is sometimes overstated. For those who don't immediately need the dividends for income, or for those who have a longer time frame needing the income, a higher growth rate on a smaller dividend can quickly result in a higher income for your portfolio.

This next table will show my projections for future income for each of the members on the list. I do this by searching through company conference call transcripts and presentations and looking at historical payout ratios, along with analysts' EPS growth projections to predict what the dividend growth rates over the next few years could be.

These numbers are then used to calculate a five-year yield on cost ("YOC") estimate, for both organic growth as well as with reinvestment of dividends. The numbers are also used along with the EPS growth estimates and the "Delta PE" number to project the total and annualized returns over the next five years.

The projections are much rosier than they were with the last update, as there are now eight stocks projected for greater than 9% annualized total returns, compared with just one last time.

The bottom end is also much better, as five companies are projected for less than 5% annualized returns, compared with seven previously. Again, two of those are Vectren and WGL Holdings, which have high share prices following merger announcements.

Those looking for immediate income are also in a better position, as there are now seven stocks yielding over 4%, compared with just four previously. There has been a lesser impact on the forward income expectations, as there are just six with projected 5-year YOCs of over 5%, compared with seven previously.

The Top Ten Picks

Considering that the utility sector is generally one purchased for income purposes, the first five of the ten were selected based on income expectations. It so happens that because of valuations and the contribution that dividends make towards total returns, these five also rank similarly high in that metric as well.

The second five were selected based on total return expectations. These are generally the higher-growth utilities that may not rank quite so well on income but make up for it with more capital gains potential.

Here are the final ten selected:

#1 - Dominion Energy Inc. makes a repeat as the top pick, and has now made the top five list on each of the articles I've written on the sector.

It has been an aggressive grower of the dividend, having grown the payout at a 9.6% annual rate over the past five years. That is expected to continue going forward, as management continues to guide for 6-8% annual EPS growth and 10% dividend growth through 2020.

Unfortunately, these positive dividend growth trends have not translated into a growing share price, as Dominion recently traded below $64 for the first time since late 2013.

This drop in price has brought the dividend yield to the 5% mark, which is quite attractive, especially if the company can execute on the 10% dividend growth forecast.

It seems the market is fearing the worst with the pending acquisition of SCANA Corp., but Dominion appears to have shielded itself from liability concerns regarding SCANA's failed nuclear power plant project. Dominion's Cove Point LNG project is also now in production, adding to cash flows and removing that risk from the equation.

Even if Dominion doesn't meet its 10% dividend growth target, the 5% yield appears safe, making this a nice opportunity for income investors.

#2 - PPL Corporation moves up one spot from last year's ranking on the back of the highest current yield of the group at 5.7%. Along with the high yield, the company brings an "A-" credit rating and a seventeen-year streak of dividend growth.

PPL has grown the dividend at a 3.3% annualized rate over the last decade, and management is targeting ~4% annual dividend growth through the year 2020.

Earnings growth has been pretty pedestrian, with just 2% annual growth over the last decade. However, 6% growth is expected in 2019, and management is targeting 5-6% EPS growth through 2020.

The current payout ratio is a tad higher than normal at just over 70%, but that isn't out of line when compared with that of its utility peers. Considering EPS growth is expected to accelerate a bit going forward, I think the 3% dividend growth target by management looks attainable.

With the stock trading near 5-year lows and the yield now up to 5.7%, this looks like a nice entry point for income investors.

#3 - The Southern Company once again makes an appearance, moving up two spots from its #5 ranking on the previous list.

The Atlanta-based electric & gas utility has a seventeen-year streak of dividend growth that has been remarkably consistent over the years. It certainly isn't a fast grower, but can be counted on for 3-4% annual dividend increases.

This was highlighted during the company's Q4 2107 conference call:

Now let me touch briefly on our dividend. Southern Company has an outstanding 70-year track record of dividends and dividend growth. Over this period, we've paid 280 consecutive quarterly dividends that have been the same or higher than the previous quarter. We are proud of this track record and continue to make thoughtful, sustainable dividend growth recommendations to our board. We fully believe the financial outlook we have presented, with its improved state-regulated profile, continues to support our objectives of growing the dividend at $0.08 per year.

Earnings growth has lagged dividend growth in recent years, which has caused the payout ratio to creep up to over 80% of earnings. This is higher than is typical for the company, but management seems confident that once the Vogtle power plant goes into service, earnings growth will pick up, and the payout ratio will fall back to more normal levels.

The stock has rebounded a bit from the lows of February, and with Southern Company announcing an $0.08 annual raise recently, shares are yielding an attractive 5.2%.

There probably won't be much in the way of capital growth from this stock, but it looks like another nice investment option for income investors.

#4 - CenterPoint Energy Inc. makes its fourth appearance on the top ten list as it moves up two spots from last year's #6 ranking.

The Houston, Texas-based diversified utility has a thirteen-year streak of dividend growth, and has raised the dividend at a 5.6% annualized rate over the last decade.

CenterPoint has generally been a higher-yield, slower-growth type of utility, as it has grown earnings at just a 2.5% rate over the last ten years. That has changed a bit of late, though, with 18% growth in 2017 and 13% growth expected in 2018.

Another development came about while I was writing this article, when on April 23rd the company announced that it would be acquiring Vectren Corp. for $72 per share. This acquisition would expand CenterPoint's service territory and roughly double its gas LDC, while adding roughly 1/3rd to its electric rate base.

Management continues to expect 5-7% annual earnings growth following the merger, and analysts agree, as they are projecting 7.5% annual earnings growth over the next five years.

The payout ratio currently sits at 71.6%, which is higher than management's guidance of a 60-70% payout ratio. This resulted in a bit smaller most recent dividend increase of 3.7%.

I've projected 5.5% dividend growth going forward, as I suspect the board will be conservative with raises as they integrate the Vectren acquisition and work to get the payout ratio back towards more comfortable levels.

CenterPoint shares are attractively valued at 16.4 times expected 2018 EPS of $1.55. With a 4.4% yield and mid-single digit growth ahead, this looks like a good entry point for long-term investors.

#5 - OGE Energy Corp. joins Dominion Energy and Southern Company as five-time repeaters on the top five list as it drops down three spots in the rankings from the last update.

OGE is the parent company of Oklahoma Gas & Electric, and holds a 25.7% limited partner interest and a 50% general partner interest in Enable Midstream Partners, LP, which is also headquartered in Oklahoma City.

It seems to fly under the radar of dividend growth investors despite having an impressive track record. The company has raised dividends for eleven consecutive years, with a 9.6% annual dividend growth rate over the last five years and 6.2% over the last ten.

OGE also has a solid "A-" credit rating, comparable to those of more well-followed stocks like Consolidated Edison, Southern Company and Duke Energy.

Management is guiding for 10% dividend growth through 2019 and a long-term EPS growth rate of 4-6%. With a current payout ratio of around 65%, I think the long-term dividend growth rate should pretty much follow earnings growth after 2019.

With a 4.1% yield, reasonable valuation, and mid-single digit growth, OGE looks like a nice opportunity for investors.

#6 - Sempra Energy makes its debut on the "growthier" portion of the top ten list. Sempra is based in San Diego, CA, and provides gas and electric services in the United States and abroad.

Sempra has a fifteen-year streak of dividend growth and has raised the dividend at a 10.1% annualized rate over the last decade. The high dividend growth should continue, as the payout ratio is reasonable at ~65% and management is guiding (page 7) for 8-9% income growth through 2021.

The stock is a bit expensive, however, as it is currently trading at more than 20X expected 2018 earnings. The total return projection is also reliant on an EPS growth projection of 10.5%, which is more than double the rate that the company has grown over the last decade.

If this growth fails to materialize, I could see the P/E contracting back to a more typical 17-18 level, which would negatively impact capital gains in the stock.

Sempra is an interesting opportunity when compared to the first five picks, which were selected primarily because of their higher current yields.

A high yield is much more of a sure thing for returns than growth is, because short of a dividend cut, a high yield is locked in at purchase. Meanwhile growth is dependent on execution by the company, and capital gains are reliant on that growth translating into a high share price.

That said, Sempra is a rare breed among utilities in that it offers high-single digit dividend growth along with a 3%+ yield. That combination is an attractive alternative to some of the slow growers in the sector.

#7 South Jersey Industries Inc. makes its third appearance on the top ten list as it moves up one spot from its ranking from 2016.

The company is headquartered in Folsom, NJ, and operates primarily as a natural gas utility in southern New Jersey. SJI has a nineteen-year streak of dividend growth and has grown dividends at a 5.9% rate over the past five years and 8.4% over the past decade.

SJI is a bit more difficult to value/forecast than others on the list considering its large drop in earnings over the past three years. Negative earnings growth in 2015, 2016, and 2017 has caused the payout ratio to expand to over 70% of the 2018 estimate of $1.58, which is much higher than the 50-60% ratio that South Jersey typically pays out.

As a result, I expect dividend growth to lag EPS growth, and I am targeting just 3% dividend growth over the next few years. Unfortunately, I have not been able to find any guidance on the dividend from management, which makes forecasting growth a bit more difficult.

The stock looks reasonably priced as long as South Jersey can hit the $1.58 estimate, and with a 3.6% yield and growth expectations of around 7.5%, it has the potential to provide double-digit total returns for investors.

#8 - NextEra Energy, Inc. is another frequent member of the top ten list, as it makes its third straight appearance. However, this utility makes it for the high growth it provides rather than for the income.

NextEra is headquartered in Juno Beach, Florida, and is one of the leaders in renewable energy in the United States. The company changed its name from Florida Power and Light "FPL" in 2010, and the new name has fit the company well as it shifts towards a "greener" power generation structure.

With a nearly $77 billion market cap, NextEra is the largest company on the watch list, which makes its higher growth rate even more impressive. It has a 24-year streak of dividend growth and produced a 9.1% annual dividend growth rate over the last decade.

This is expected to continue going forward, as management recently guided for 12-14% dividend growth through at least 2020 as it works toward a targeted payout ratio of 65%.

The current payout ratio sits at just 57.4%, so those future double-digit dividend increases sure appear to be sustainable for several more years.

The only problem with NextEra is valuation, as shares are trading for more than 21X 2018 estimates of $7.75. This isn't a new development, as it has traded at a premium to historical valuations going all the way back to 2012.

I sat on the sideline for several years waiting to purchase, but finally made the plunge and opened a position in December. So far so good, as I'm up 5% on the buy.

I'm generally not one to ignore valuations, but NextEra is one where I chose to do so. There aren't many utilities out there with the consistent growth that it provides.

#9 - Duke Energy Corp. makes its fourth appearance on the top five list, as the Charlotte, NC-based gas and electric utility's 4.6% yield keeps it high in the rankings.

Duke is another slow and steady type of utility. It has a thirteen-year streak of dividend increases, with 2.9% growth over the last five years and 3.1% over the last ten.

Growth has ticked up slightly of late, as its latest increase was 4.1%. My expectations are for 4% dividend growth going forward (which slightly lags the analysts' 4.5% earnings growth target), due to the payout ratio of 75.7% being slightly above the 70-75% targeted range from management.

At 16.5 times expected 2018 earnings, Duke is now trading near my fair value target. This seems like a decent entry point for income investors, as the 4.6% yield is attractive and the expected 4% growth rate should more than keep up with inflation going forward.

#10 - Black Hills Corporation rounds out the list, making its first appearance in the top ten.

The diversified utility is based in Rapid City, South Dakota, and is one of the smaller companies on the list with a market cap of just $3.1 billion. It appears to be lightly followed, with just three focus articles written about it on Seeking Alpha in the last two years.

That doesn't mean it hasn't performed well, however, as the company has an impressive 48-year streak of dividend growth. That was extended in November, when it announced a 6.7% increase to the payout. This continued a recent trend of higher dividend growth, as Black Hills Corp. had a 20-year dividend growth rate of 3.2% and a 10-year growth of 2.8%.

The payout ratio is in the middle of the 50-60% range (page 22) target given by management. Analysts are expecting 4% annual earnings growth over the next five years, and I expect dividend growth to roughly track that going forward.

Shares of Black Hills Corp. have bounced in recent months, but are still reasonably priced at about 17X expected 2018 earnings. This looks like another decent opportunity of investors.

Watch List Archive and Live Data

If anyone is interested in reading my past coverage of utilities on Seeking Alpha, I've included links to all previous articles on my website. I've also shared a Google Docs sheet there with all of the updated data used for this article.

I update the collected data once or twice a year, but other things like share price, valuations, 52-week high/low information, and return projections are updated automatically in the spreadsheet. I hope this information is helpful for readers researching the sector.

Conclusion

It's been a bumpy ride for the utilities since the last update, as rising interest rates have moved investment dollars out of higher-yielding equities and into bonds. This has caused share prices to fall, creating some better opportunities for income investors in the sector.

There has also been plenty of consolidation in the sector, as two companies were removed from the watch list following acquisitions, and another two are likely to be removed in the future.

Hopefully this update helps those looking for investment ideas and provides some positive insight into the utility sector. If you would like to read future articles covering this and other sectors, I kindly as you to click the "Follow" button next to my profile at the top of the page.

Analyst’s Disclosure: I am/we are long D, XEL, WEC, NEE. 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.

I am an 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.