Published by Bob Ciura on March 15th, 2017
Income investors should consider adding some U.S. utility stocks to their portfolios.
Utilities are extremely stable. Electricity and gas are defensive industries. They see continuous demand, even during recessions.
This allows them to be consistent dividend payers over long periods of time.
Duke (DUK) and Xcel (XEL) are both Dividend Achievers, a group of 271 stocks with 10+ years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Duke has paid dividends for more than 90 years.
Xcel, going back to its days as Northern States Power, has paid dividends for over six decades.
Duke and Xcel are very similar companies. They both provide electric and natural gas services, mostly in regulated markets.
This article will discuss which of these two U.S. utility giants, could be the better dividend stock to buy today.
Business Overview
Winner: Xcel
Xcel Energy is a fully-regulated utility. It has operations in eight U.S. states, mostly in the West and Midwest.
Its customer base includes 3.5 million electricity customers, and 2.0 million natural gas customers.
Source: March 2017 Morgan Stanley Conference, page 20
Approximately 90% of Xcel’s earnings come from electricity, with the remaining 10% from gas.
Duke is also an electric and gas utility. It has a large regulated utility business that has approximately 7.4 million electric customers. Duke Energy’s customers are located in six states in the Southeast and Midwest.
It also distributes natural gas to more than 1.5 million customers in the Carolinas, Ohio, Kentucky and Tennessee.
Source: 4Q Earnings Presentation, page 4
The company’s electric utility business comprises nearly 90% of its total earnings.
Duke’s adjusted earnings-per-share rose 3.3% in 2016. Growth was driven by favorable weather conditions, cost controls, and acquisition-related synergies.
Meanwhile, Xcel’s adjusted earnings-per-share grew 5.7% last year. Like Duke, it also benefited from favorable weather. It had the added advantage of stronger rate increases.
Both Xcel and Duke have a ‘A-‘ credit rating from Standard & Poor’s.
They both have strong business businesses, built around regulated markets.
But, due to its more favorable rate outcomes and slightly stronger financial performance last year, Xcel gets the nod.
Growth Prospects
Winner: Toss-Up
Duke and Xcel have virtually identical growth strategies.
In both cases, their three biggest growth initiatives going forward are shifting to regulated operations, investing in renewables, and expanding in natural gas.
And, both companies expect long-term earnings growth of 4%-6% each year.
Regulated markets are typically more stable than unregulated markets, because it allows utilities to generate regular rate hike approvals.
Xcel is restructuring its financial framework around regulated businesses.
Source: March 2017 Morgan Stanley Conference, page 13
Duke is following suit. It has made $25 billion of infrastructure investments over the past 10 years, centered on regulated markets.
Source: 4Q Earnings Presentation, page 9
Separately, Duke pushed further into regulated markets in 2012, when it merged with Progress Energy in a massive $32 billion deal.
In addition, Duke exited its international business to focus more on domestic regulated businesses.
As a result of these moves, Duke will generate nearly 100% of future profit from its regulated business.
And, both companies are investing in renewable energy sources.
By 2021, more than one-third of Xcel’s energy will be generated from renewable sources, like wind and solar.
Source: March 2017 Morgan Stanley Conference, page 7
Xcel expects to invest $18.4 billion in capital expenditures from 2017-2021, 19% of which will be allocated toward renewable energy.
This is expected to fuel 5.5% compound annual growth in Xcel’s rate base.
Source: March 2017 Morgan Stanley Conference, page 10
By 2021, approximately 10% of its rate base will come from renewables, up from 4% in 2016. Renewable energy is expected to contribute the highest growth for the company moving forward.
By 2026, Duke will derive 9% of its energy from hydroelectricity, wind, and solar, up from 2% in 2005.
Lastly, Xcel’s natural gas earnings rose 4% last year.
Duke has boosted its own natural gas business, largely through acquisitions. In 2015, it acquired Piedmont Natural Gas for $4.9 billion.
The acquisition tripled Duke’s natural gas customers, by adding 1 million natural gas customers to its existing customer base of 525,000.
Going forward, Duke expects to generate steady growth from these initiatives.
Source: 4Q Earnings Presentation, page 14
The regulated and natural gas businesses are expected to grow by 6% per year through 2021. This is projected to fuel 4%-6% growth in adjusted earnings-per-share over that time.
Dividends
Winner: Duke
Duke pays an annualized dividend of $3.42 per share. This works out to a 4.2% dividend yield based on its recent share price.
For its part, Xcel has a 3.3% dividend yield.
Both stocks yield significantly more than the average stock. The S&P 500 Index as an average dividend yield of 2%.
But Duke has a big advantage. The stock generates roughly 27% more annual income for investors than Xcel.
Part of the reason for this is because Duke maintains a higher payout ratio.
Xcel distributed 62% of its earnings-per-share over the past 12 months, compared with a 73% payout ratio for Duke.
The trade-off is that Xcel typically raises its dividend at a higher rate than Duke. Xcel raised its dividend by 5.9% in February 2017.
Duke’s last dividend raise was a 3.6% hike last year.
Xcel expects to increase its dividend by 5%-7% per year.
Duke intends to maintain a 70%-75% payout ratio going forward. It expects to increase its dividend by 4% per year moving forward.
If Xcel raises its dividend by 6%, compared with 4% for Duke, it will take 15 years for Xcel’s yield on cost to surpass Duke Energy’s.
As a result, while Xcel could be a better choice for investors with a very long time horizon, Duke is the better pick for income now.
Final Thoughts
Duke and Xcel have extremely similar business models, and future growth strategies. Both companies are high-quality utilities.
It would be fairly easy to argue that both stocks deserve a place in an income investor’s stock portfolio. They have both paid consistent dividends for decades, without interruption.
That being said, they have different dividend policies.
Duke is willing to part with more of its cash flow each year than Xcel. Its higher payout ratio means investors receive a much higher dividend yield, which makes a big difference for dividend investors.
As a result, Duke is the better utility dividend stock.
