- Utilities sector has negative return and is worst-performing in 2023 due to rising interest rates.
- Steep share price declines have led to utilities trading at lowest valuation with highest dividend yields in years.
- Three undervalued utility stocks with dividend growth potential: Black Hills Corporation, Eversource Energy, UGI Corporation.
So far, 2023 has been unkind to utilities. The sector has a negative return and is the worst-performing one year-to-date. This point is unsurprising because rising interest rates have probably caused investors to prefer short-term U.S. Treasury bills and bonds over utilities. For instance, the Vanguard Utilities ETF (VPU) only yields about 3.5%. In comparison, T-bills and bonds with a duration of 1 year or less yield 5%+.
However, this year may be an opportunity to buy utility stocks at a discount. Because of steep share price declines, many utility stocks are trading at the lowest valuation with the highest dividend yields in years.
We discuss three undervalued utility stocks that are also dividend growth stocks for long-term income.
Criteria for Selection
To pick the three stocks, we require specific criteria to be met. The bullets below outline what we desire in employing a stock screener on Portfolio Insight.
- A minimum dividend yield of 4%.
- At least five years of dividend growth for Dividend Challenger status.
- A payout ratio of less than 75%.
- Undervaluation based on historical price-to-earnings [P/E] ratio.
3 Utilities for Long-Term Income
Black Hills Corporation
Black Hills Corporation (BKH) is the first stock on our list. It is a diversified electric and natural gas utility operating in Colorado, Nebraska, Iowa, Missouri, Montana, South Dakota, and Wyoming. The firm generates 1.4 gigawatts of power and has ~9,000 miles of electric lines and 47,000 miles of natural gas lines. In total, Black Hills serves 1.33 million customers. Total revenue was $2,551.8 million in 2022 and $2,586.5 million in the last twelve months.
The company is interesting because it is essentially a pure-play regulated utility. Hence, Black Hills has a monopoly in its operating area without the risk of non-regulated operations. The firm grows by adding to its asset base and periodically raising rates. Revenue has increased from 8% to 9% annually, and earnings per share at a lower rate of 6.6% in the past decade because of rising share count.
From a dividend perspective, Black Hills is a rock star. It is one of only three electric and gas utilities that are Dividend Kings. It has 53 years of increases and, on average, raises its dividend by 5% to 6% annually. The last dividend increase occurred in October 2022, and shareholders should expect another one this October 2023.
The forward dividend yield is about 4.5%, the highest in a decade and well above the 5-year average of 3.33%. The yield comes with excellent dividend safety, too. A 66% payout ratio is relatively conservative for utilities and provides confidence about future increases. Operating cash flow [OCF] of $747.8 million in the last twelve months covers the dividend requirement of $162.7 million several times. Also, the dividend quality grade, a measure of safety based on growth, profitability, and the balance sheet, is an 'A.' Consequently, there is less risk of a cut or omission.
Black Hills' valuation is low based on trailing metrics. The equity is typically at a price-to-earnings [P/E] ratio of 17X to 19X. Currently, it trades at a valuation of ~13.6X earnings. I view Black Hills as a steal.
The second stock on our list is Eversource Energy (ES), another diversified utility in Connecticut, Massachusetts, and New Hampshire. It is one of the few utilities to provide electricity, natural gas, and water service. The firm has 3.29 million electricity, 890,000 natural gas, and 237,00 water customers. Total revenue was $2,551.8 million in 2022 and $2,586.5 million in the last twelve months.
Eversource is the largest regulated utility in the Northeast United States. Interestingly, long-term EPS is growing at a decent pace despite the low population growth in the region. The company is aggressively upgrading its transmission and distribution capabilities, increasing efficiency, improving customer service, reducing emissions, and lowering costs. As a result, EPS has grown at 6% CAGR in the past decade. EPS growth should be even faster in the next several years as the firm is projecting a rate base growth of 50%.
The firm also grows by acquiring smaller utilities, like Aquarion in 2017 and Columbia Gas in 2020. The firm will probably conduct further M&A in water utilities, a fragmented space. Eversource is also investing significantly in renewable energies. Notably, it is spending billions in a joint venture to generate 1,758 megawatts of offshore wind power.
Eversource is another dividend growth utility, achieving Dividend Champion status with 25 years of increases. The growth rate is roughly 6% annually. The last increase was in January 2023. The declining share price has pushed the dividend yield up to ~4.2%, a 10-year high. The elevated yield comes with a solid payout ratio of around 62% based on earnings and 40% on OCF. Moreover, the dividend quality grade is an 'A+.'
Like most utilities, Eversource's share price has declined because of climbing interest rates. Consequently, the forward P/E ratio is approximately 14.7X, well below the range of the past five and ten years. Eversource is a long-term buy.
The third stock on our list is UGI Corporation (UGI), a unique regulated and non-regulated utility. Besides its regulated electricity and natural gas businesses, it also stores and transports natural gas in the unregulated market. The regulated utilities provide natural gas to approximately 677,000 customers in Pennsylvania, 214,000 customers in West Virginia, and 550 customers in Maryland, and electricity to about 62,600 customers in northeastern Pennsylvania. In addition, the firm owns AmeriGas Propane, the market leader in retail propane distribution with 1.3 million customers. Lastly, the firm is engaged in Europe's liquefied petroleum gases [LPG] market.
Total revenue was $10,106 million in 2022 and $9,458 million in the last twelve months.
UGI Corporation is positioned for growth in both its regulated and unregulated businesses. The utility's rate base is growing by about 10% annually. Although the wholesale propane business has decent potential, it is currently affected by oversupply, energy conservation, and disruption caused by the conflict in Ukraine. AmeriGas Propane is a market leader but is currently faced with labor shortages. However, the firm's scale and market leadership should let grow again after 2023.
The utility has paid a dividend for more than one hundred years. In addition, the UGI Corporation is a Dividend Champion with 36 years of increases in a row. The forward dividend yield has surged to ~6.6%, the highest in ten years. But dividend safety is top notch with earnings and OCF payout ratios of ~49% and ~42%, respectively.
UGI Corporation is clearly undervalued based on a P/E ratio of 8.2X, below the 5-year and 10-year ranges. I view the equity as a deal now.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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