Duke Energy (DUK) is a favorite high-yield dividend stock for income investors, and it’s no wonder why. The company has paid uninterrupted quarterly dividends for 90 years and is set to increase its dividend for the ninth consecutive year in 2016.
Regulated utility companies such as Duke can provide safe retirement income with less risk than other types of businesses because of their predictable earnings, government-supported competitive advantages, and relatively low stock price volatility.
For these reasons and more, we own several utility stocks in our Conservative Retirees and Top 20 Dividend Stocks portfolios. However, just because a stock appears to have little fundamental risk does not mean it is a safe investment. The price paid for a stock is still very important, and that is especially true for low-growth utility stocks.
While utility companies can be relatively attractive income investments compared to bonds due to their potential for capital appreciation and moderate income growth, it’s still important to diversify a portfolio’s income streams in other sectors. Unexpected shocks can still happen across entire sectors, and no one living off dividends in retirement desires to deal with unpleasant, avoidable surprises when it comes to their nest egg.
Let’s take a closer look at Duke Energy’s business to see if it’s a stock we should consider for our utilities exposure.
Business Overview
Duke Energy’s history dates back to the early 1900s, and the company is largest electric utility in the country today with over $23 billion in annual revenue and operations reaching across the Southeast and Midwest regions. Duke Energy is a regulated utility company that serves approximately 7.4 million electric customers and 1.5 million gas customers, including customers from its planned $4.9 billion acquisition of Piedmont Natural Gas (more on this later).
Regulated utilities account for about 90% of Duke Energy’s business mix, but the company also has a commercial portfolio of renewables and gas infrastructure (5%) and an international energy business in Central and South America (5%), which it recently put up for sale.
The company’s regulated utilities primarily rely on coal (29%), nuclear (27%), and natural gas (23%) for its generation of electricity. Hydro and solar generate another 1% of the company’s total energy, and Duke Energy also purchases about 20% of its power.
Source: Duke Energy Investor Presentation
Business Analysis
Regulated utility companies are essentially monopolies in the regions they operate in. With the exception of Ohio, all of Duke’s electric utilities operate as sole suppliers within their service territories.
Building and operating the power plants, transmission lines, and distribution networks to supply customers with power costs billions of dollars, and it would generally be unprofitable and inefficient to have more than one supplier for a region. State utility commissions also have varying degrees of power over the construction of generating facilities, which further restricts competition.
The downside to the “monopoly” enjoyed by regulated utilities is that their services are priced by state commissions. This is done to keep prices fair for consumers and allow utility companies to earn a reasonable, but not excessive, return on their investments to encourage them to provide safe and reliable service.
A utility company’s attractiveness is largely driven by the states it operates in. Some have more favorable demographics (e.g. population growth) and regulatory bodies. Duke Energy’s mix is generally favorable. Over the past three years, base rate cases approved to Duke Energy have granted the company a return on equity ranging from 9.8% to 10.5% across the Carolinas, Ohio, and Florida.
We think these returns are very reasonable and suggest a generally favorable set of regulatory bodies in Duke’s core operating states.
