Published on June 5th, 2018 by Josh Arnold
Utility stocks tend to be coveted by income investors as they offer generally stable stock prices compared to the broader market, and as they typically pay meaningful dividends. The group has suffered a bit since rates began to rise and as a result, there are bargains to be had.
Still, many utilities pay dividend yields well above the S&P 500 average yield. We currently track 246 utility stocks that pay dividends to shareholders. You can download the list below:
The rankings in this article are derived from our expected total return estimates from the Sure Analysis Research Database. The five utility stocks with the highest projected total returns are ranked in this article, with #1 having the highest expected total returns in the group.
Rankings are compiled based upon the combination of current dividend yield, expected change in valuation as well as forecast earnings-per-share growth to determine which stocks offer the best total return potential for shareholders.
Read on to see which utility stock ranks as the most attractive for investors today.
Top 5 Utility Stock #5: Dominion Energy (D)
Dominion Energy is a large electric utility that is headquartered in Richmond, Virginia. Dominion Energy is valued at $44 billion and has more than six million customers in eight states. Dominion recently announced that it sees 2018 adjusted earnings per share in a range of $3.80 to $4.25, which means a year over year growth rate of 6% to 18%.
Source: Q1 Earnings Slide, page 15
The slide above shows the positives that came from the company’s recently reported Q1, including some operational milestones as well as very strong dividend growth targets.
Earnings have grown by 2.9% over the last decade, but over the last five years the growth rate has accelerated meaningfully to 5.5%. For the current year Dominion expects a double-digit earnings growth rate, which can be explained by several contributing factors. First, the company will benefit substantially from tax rate changes. Second, additional growth will be seen from the start-up of the Cove Point LNG project, which was recently expanded and allows for the import and export of liquefied natural gas.
Dominion Energy is also trying to acquire SCANA (another electric utility), but SCANA’s failed nuclear power project (V.C. Summer) is making this a relatively complicated situation. SCANA has 700,000 customers and taking it over would be accretive for Dominion Energy’s EPS and cash flows per share, but Dominion Energy has stated that they will pull back the takeover offer if SCANA is not allowed to recover the costs of its V.C. Summer nuclear project.
Dominion’s shares trade relatively in line with the 10-year average valuation, meaning we don’t see a sizable impact from the valuation moving in either direction. Dominion’s dividend yield is at the high end of the historic average, which, coupled with the promise of significant dividend increases over the coming years, makes shares look attractive for income investors.
Expansion into new projects, tax tailwinds and the possible takeover of SCANA will lead to solid earnings growth going forward. That, combined with a reasonable valuation, a high dividend yield and the outlook for compelling dividend growth over the next couple of years should lead to attractive total returns going forward. We forecast 11.7% total returns going forward, consisting of the current 5.2% yield, 5.8% EPS growth and a 0.7% tailwind from the valuation.
Top 5 Utility Stocks #4: PG&E Corporation (PCG)
Pacific Gas & Electric was formed back in 1905 and has been providing energy solutions for much of northern California since. The San Francisco-based company has 20k employees and serves 16 million customers. It has a market cap of $22B and should produce just under $18B in revenue this year.
PCG recently reported Q1 earnings and while EPS fell from $1.06 the prior year to $0.91 in Q1 2018, the real story is the northern California wildfires. PCG shares have plummeted in recent months on the potential liabilities the company faces from the fires; these liabilities could top $1B under an adverse scenario due to California’s inverse condemnation clause. PCG suspended its dividend recently to conserve cash in order to fund its wildfire liabilities, and this is weighing heavily on investor sentiment.
Source: Earnings Presentation, slide 12
This slide shows that while PCG has its issues right now, its ratebase growth remains strong at roughly 8% per year. This should help drive revenue and earnings growth apart from the legal challenges that it is facing.
Revenue has grown pretty steadily, averaging 2% annually for the past decade; EPS have done anything but. The company’s results have been impacted by everything from its cost saving initiatives to natural disasters. PCG’s diversified revenue stream is a sizable asset to the company, however, and we expect that as power demand continues to rise in the heavily populated area that PCG services, revenues will follow suit. We also see a small tailwind for margins as the company buckles down with expenditures, particularly important in light of the wildfire liabilities PCG is likely facing.
However, we see PCG as unable to pass wildfire liabilities on to customers. Five-year EPS growth should therefore come in at 3% annually with the caveat that a significant amount of risk is present in the near term, pending what happens with PCG’s appeals. Importantly, the dividend was suspended recently and we do not expect any payout in 2018. However, once the full extent of liabilities is known from the wildfires, PCG certainly has the financial capacity to reinstate its payout.
Overall we see PCG as significantly under fair value here but with the caveat that there are material risks involved in owning it. Total returns should be 12.8% annually for the next five years, consisting of no current dividend, a 9.8% tailwind from the valuation moving higher and 3% EPS growth. That makes PCG look compelling for those seeking value but the risks involved from the lack of transparency from wildfire liabilities means the next couple of years could see a lot of volatility.
PCG is unique among utilities in that it isn’t paying a dividend and has an enormous potential liability overhang, but if the final tally comes in lower than expected, returns for patient shareholders could be sizable. PCG is not for the risk-averse at this point and won’t be until we have clarity on its final wildfire bill, which may take years.
Top 5 Utility Stocks #3: Fortis, Inc. (FTS)
Fortis is Canada’s largest investor-owned utility business with operations in Canada, the United States, and the Caribbean. It has a market capitalization of US$13.7 billion and has increased its dividend for 44 consecutive years.
Fortis’ recently reported Q1 results were in-line with the market’s expectations. Fortis saw sales decline by 3.4% (largely due to foreign exchange fluctuations) but managed to offset this top-line erosion through prudent cost management. Adjusted EPS declined by 2.8% due entirely to a significant, one-time increase in the number of shares outstanding (Fortis issued $500 million of common equity in March of 2017). However, adjusted net earnings increased by 2.1%.
Source: Earnings Presentation, page 5
The company’s rate base growth is being supported by its strong capex spending, which is being funding by robust operating cash flow performance. Fortis’ future growth is largely coming from this virtuous cycle of spending that produces rate base growth, and as seen above, there is little reason to doubt this will continue.
Fortis has compounded its EPS at 6.4% per year since 2008. Looking ahead, we believe that continued ~6% annualized earnings-per-share growth is feasible. However, this year is expected to be a flat or slightly down year for Fortis’ EPS, as we are expecting $2.60 for 2018. Applying a 6% growth rate to this earnings estimate allows us to calculate a 2023 bottom line projection of $3.48.
Fortis’ future growth will be driven by a substantial capital expenditure plan that the company is currently executing. More specifically, Fortis is working through a $15.1 billion capital investment program that is expected to increase its rate base to $33 billion by 2022, which implies a five-year compound annual growth rate of 5.4%. The capital expenditure plan is focused on areas like grid improvement, natural gas distribution, cyber protection, and clean energy. Importantly, this growth rate is before the impact of acquisitions, which have historically been important for Fortis; for example, Fortis closed the $11.3 billion acquisition of Michigan-based ITC Holdings Corporation in late 2016.
Even using very conservative assumptions, Fortis appears positioned to deliver double-digit total returns over long holding periods. Moreover, the company is likely to do so with far less volatility than the stock market averages. We are forecasting total returns of 13.4% annually, consisting of the current 4.1% yield, 6% EPS growth and a 3.3% tailwind from an increase in the valuation. Accordingly, we are recommending Fortis as a buy for conservative, income-oriented investors who are averse to portfolio volatility.
Top 5 Utility Stocks #2: AmeriGas Partners, LP (APU)
AmeriGas Partners is a publicly traded limited partnership that was formed in 1959. It distributes propane nationwide to both residential and commercial customers and sells related equipment and supplies. It has a market value of $3.9B and produces $2.9B of revenue annually. APU is one of 125 MLPs we track. You can see the full list below:
APU’s recent Q2 report was very strong as adjusted EBITDA was 14% higher than the comparable quarter last year. Retail volume was 10% higher than last year thanks to weather that was 14% colder – driving incremental demand for heating – but National Accounts and Cylinder Exchange also performed well, as volume for both grew in excess of 15%. APU experienced a tough year in 2017 due to warmer-than-expected weather. The longer, cooler winter and spring thus far this year has seen APU do very well. In addition, APU saw a slight bump in margins thanks to the extra volume.
Source: Earnings Presentation, page 9
This slide shows how much the company’s earnings are dependent upon weather as a return to more normalized conditions resulted in a 29% increase in adjusted EPS.
Most of APU’s revenue is tied to heating and thus, when it sees warmer-than-expected temperatures – like it did in 2012 and 2017 – profitability can suffer mightily. Obviously, one cannot predict the weather, but APU’s long term fundamentals are still intact even if the weather isn’t always friendly.
We are forecasting 5.4% EBITDA growth annually for the next five years as APU should continue to see rising volumes as well as a slight tailwind from higher margins, with the caveat that addition dilution is a possibility at any time. APU, like other partnerships, issues new units from time to time to raise capital but hasn’t done so on a significant scale since 2014.
The all-important distribution should continue to grow as well, although expansion from here will be rather slight. We see low single digit growth for the payout, rising to $4.20 in five years from the current $3.80. APU’s indebtedness may make it challenging to raise the payout more quickly than that, but we don’t see the distribution as being in danger.
Recent years of under-performance have created a stock that looks fairly valued with decent growth prospects, as well as a huge current yield. We see total returns coming in at 15.1%, consisting of 5.4% EPS growth, a 0.6% tailwind from the valuation and the 9.1% current yield. APU would therefore be suitable mostly for income investors but value investors may be willing to take a look here as well.
Top 5 Utility Stock #1: Suburban Propane (SPH)
Suburban Propane has been in operation since 1928 and became a Master Limited Partnership in 1996. The company services most of the US with propane and other energy sources, although propane does make up around 90% of total revenue. It has a market cap of $1.4B and should do about that amount in revenue this year.
SPH’s recent earnings report showed vast improvement over the prior year’s comparable quarter as the weather was finally conducive to stoking demand for heating fuels. Two very tough years of warmer-than-expected temperatures have crimped results but this year’s Q1 saw adjusted EBITDA rise 10.6%. SPH also recently cut its distribution after years of weak results so there have been a number of headwinds for the stock. However, Q1 results looked fairly strong as volumes grew.
Source: Investor Factsheet
This investor factsheet gives us a good look at where SPH operates most heavily and why winter weather is so critical for the company’s results; it gets the largest chunk of its revenue from the Northeast and almost half of its total volume is from residential customers.
EBITDA has been predictably volatile during the past decade as it is all down to the weather for SPH. It has the ability to produce strong operating leverage should temperatures return to normal or even slightly below normal, but we are cautious on its growth because of the uncertainty of the weather and SPH’s reliance upon it. We see modest 3.7% average annual growth for the next five years as SPH continues to grapple with volumes.
This year should see a meaningful rise in revenue but further out, we are expecting low single digit revenue growth combined with a small margin tailwind on more normalized weather patterns. Of course, all bets are off if the weather stays very warm and reduces heating days in its territories. This is the principal risk to owning SPH and that is why the stock is priced the way it is today.
SPH recently cut its distribution after it became clear it was unsustainable. The company had been borrowing to pay the distribution so cutting it made sense, but even with the lower distribution, the much lower stock price has driven the yield up significantly. We are forecasting a flat distribution given the factors already discussed and the fact that it was only recently cut; an increase seems unlikely for the foreseeable future given these inputs.
Overall, SPH is an attractive investment with its forecasted annual returns of 23.5%. Total returns will consist of the current 10.5% yield, a 9.3% tailwind from the valuation and 3.7% EBITDA growth. SPH is very attractive for income or value investors as the yield is still quite high and the stock is cheap. The distribution should be safe at its current levels for the foreseeable future, offering income investors the chance to grab a 10%+ yield.
SPH is not without risks but the current stock price and distribution seem to be pricing these risks in – and then some. We recommend SPH as a buy for investors who can stomach its weather-based volatility and elevated risk from high debt levels.
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