Dividend investors love utilities. That’s not surprising. These companies usually provide solid yields and stable dividends.
This is despite the fact that SafetyNet Pro ranks most utilities a C or lower.
And there’s a simple reason for that…
Cash flow is key to dividend safety. Utilities use debt to finance operations and dividends. So their cash flows are poor.
It’s something to think about if interest rates move significantly higher…
Steady dividend payers may not be able to make such large payouts if their financing costs are higher.
Let’s take a look at a utility requested by a Wealthy Retirement reader…
PPL Corp. (NYSE: PPL) provides electricity and gas to customers in Pennsylvania, Kentucky and the U.K.
The 97-year-old company pays a 4.1% yield. It has raised its dividend for 16 years in a row. In 2017, management said to expect a 4% increase to its dividend, which would boost the current yield to 4.4%.
But is that dividend safe?
In 2016, PPL generated $2.89 billion in operating cash flow, a healthy 10% more than the previous year. But when you take into account capital expenditures of $2.91 billion, free cash flow is negative.
That means by operating its business, PPL sent $20 million out the door. Meanwhile, it paid shareholders $1 billion in dividends. Where does that money come from?
PPL has $341 million in cash and $17.8 billion in long-term debt.
Like many utilities, PPL finances its capital expenditures and operations. That means it’s borrowing money to pay the dividend. That’s not good.
Negative free cash flow is penalized in SafetyNet Pro’s ratings. No matter how long a company has raised the dividend, if free cash flow is negative, it is very tough to get a high rating.
Earnings and EBITDA are both expected to drop in 2017. That’s another negative. Over three years, however, both of those numbers are projected to climb.
