Electric and natural gas utility Duke Energy (NYSE:DUK) just reached a settlement agreement with environmentalists and regulators over the cleanup of coal waste. If approved, it will remove an issue that’s been hanging over the company for some time. But is that enough to make Duke a buy for your portfolio?
The background on Duke
At its core, Duke isn’t a particularly exciting company. It generates and distributes electricity to 7.7 million customers in six states and distributes natural gas to 1.6 million customers in four states. It has a contract-based renewable power business, but it’s relatively small compared to its traditional utility operations. Duke is the prototypical conservative utility, so safe and consistent that even the most risk averse investors could feel comfortable owning it.
Part of that ties back to the utility’s dividend. The yield is around 4.1%, which is more than twice what an investor would get from an investment in an S&P 500 index fund. The dividend has been increased annually for 16 consecutive years, at a roughly 3% annualized rate over the past decade. That rate of increase is approximately in line with the historical rate of inflation growth, meaning that the dividend has retained its buying power over time. Faster growth would have been better, of course, but for a conservative investor, not losing ground with at least a portion of a larger portfolio is a solid outcome.
That’s notable given the low beta of Duke’s stock. Beta is a measure of volatility relative to the broader market. Beta waxes and wanes over time, but Duke’s beta tends to be modest compared to other types of investments, like technology stocks, which are more volatile. So it can provide something of a foundation for a larger portfolio.
So far, Duke sounds like a pretty good option for conservative dividend investors. The coal ash settlement noted above, meanwhile, will likely remove a bit of uncertainty around the company’s future that some investors had been worried about. Essentially, Duke is cleaning up coal-related waste but had been facing pushback from regulators and environmentalists. A lot was up in the air, including how the cleanup would be paid for. If things go as planned, the company will take a large, one-time write-off, which is a net negative, but the future will be more certain with customers helping to foot the bill.
So buy it?
This backdrop, however, is only one piece of the equation. There’s more to consider. For example, the dividend yield is toward the low end of Duke’s historical yield range. That’s true over both a short-term time frame — say, the last decade — and the longer term. This suggests that Duke’s stock is trading hands at something of a premium to historical levels.
Looking at valuation another way, Duke’s P/E ratio of 34 is rather high right now. There are one-time items in that figure, so it is elevated above what one would normally expect. But the company’s valuation being high right now is also backed up by relatively lofty price-to-sales and price-to-book value ratios. These ratios tend to see less impact from one-time items. So it is fair to suggest that Duke is not cheap today.
That said, Duke is expecting earnings growth of 4% to 6% a year through 2024 based on its capital spending plans (totaling $56 billion over the next five years or so). Pair that with the roughly 4% dividend and you get a nearly 10% return, which is pretty hard to complain about. And, notably, the company’s capital investments have to be approved by regulators, so estimates of future spending are generally pretty reliable. The dividend, meanwhile, should grow along with earnings, though perhaps at a slightly slower rate. A key piece of the spending here will be for the transition toward cleaner energy options.
So investors are paying at least full price for a boring utility that is expected to produce solid performance over time. That’s not a great deal, but it probably isn’t exactly bad, either, given the elevated state of the broader market. Truly conservative investors and those with a value bias might not want to jump aboard right now, preferring to wait for a pullback. But those seeking to add a dividend-paying utility stock that will help diversify a broader portfolio probably wouldn’t be making a bad choice, even if a cheaper entry point would be preferable.
Not an easy call
An investment in Duke Energy at current prices is no slam dunk. It is not cheap, even though the company is likely to be a pretty reliable performer. The key is to consider it against the broader investment universe. If you are looking to put some money to work today, the above-market yield, stable (perhaps boring) business, and long-term investment plans suggest that it would be a decent option for diversification purposes. Just know that you are paying at least full price for the stock.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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