Utility Yields Suffer Winner's Curse

9/25/2017


Helped by this year's drop in long-term bond yields, the S&P 1500 Utilities sector may be able to outperform the broad index for the third year in the past four. The S&P 1500 Utility Sector Index has delivered a total return of 13% in 2017, versus a similar return for the S&P 1500 Index. Since the end of 2013, the sector has returned 61% including dividends, versus the index's 46% cumulative return.

But earnings and dividends have not kept pace with utility share prices. Consequently, dividend yields and P/E ratios are going in the opposite direction to what investors want to see.  

The average utility stock in the S&P 1500 Index yields 3.0%, near its lowest level since 1994 and well below the 23-year norm of 4.1%. On just 2% of month-ends has the sector's average yield been lower. The spread between the current and historical dividend yield is wider for utilities than for any of the index's other 10 sectors.

Utilities average trailing P/E ratios of 21.6, above their norm since 1994 of 17.0. The sector has sported a higher average P/E on just 2% of month-ends since 1994. In Quadrix, utilities average Value scores of 52, versus their long-run average of 62.

Our Top 15 Utilities Portfolio yields 3.0%, in line with the average S&P 1500 utility stock. We focus on stocks capable of increasing their payouts, as illustrated by nine of the 15 stocks in our portfolio delivering above-average dividend growth over the past three years. Our Top 15 picks average current-year estimated P/E ratios in line with the sector norm.

Below, we review three Top 15 components that look especially attractive for income investors. On page 6, we explain a swap in the Top 15 components.

At first glance, DTE Energy ($109; DTE) hardly stands out for its dividend. The stock yields 3.0% and has grown the distribution at an annualized rate of 6% over the last three years, both in line with sector averages. But DTE raised its dividend twice in the second half of 2016, with hikes of 5% and 7%.

DTE operates electric (46% of sales) and natural-gas (12%) utilities in Michigan. It also delves into energy trading (23%), power and industrial projects (17%), and gas storage and pipelines (3%). Per-share profits climbed 20% and revenue 28% in the 12 months ended June, partly due to acquisitions. DTE is a component of the Top 15 Utilities portfolio.


EQT Midstream Partners' ($74; EQM) stock has struggled in 2017, hurt by uncertainty surrounding its parent. EQT ($65; EQT) spun off EQT Midstream as a master limited partnership (MLP) in 2012 but continues to indirectly hold a 26% stake in the pipeline company. In June, EQT agreed to acquire Rice Energy ($29; RICE) in a $6.7 billion deal that would let EQT Midstream inherit Rice's midstream assets. But an activist investor is trying to block the Rice deal, urging EQT to disentangle itself from the pipeline business.

EQT Midstream remains attractive in Quadrix, earning a Value rank of 86 and Overall rank of 94. The MLP has raised its dividend in 18 straight quarters, with the hikes averaging 6%. EQT Midstream is also a Long-Term Buy.


NextEra Energy's ($147; NEE) operating profit margin is on pace to rise for the sixth straight year, the result of the electric utility's efforts to reduce fuel costs. Management targets dividend growth of 12% to 14% through at least 2018, up from 10% annual growth over the past three years. NextEra seeks to grow per-share profits 6% to 8% a year through 2020.

NextEra said all 35 of the counties it serves in Florida experienced damage from Hurricane Irma, interrupting service for 4.4 million of its 5 million customers across the state. Not surprisingly, analyst profit estimates have contracted for both the September and December quarters, though estimates are rising for 2018, with the consensus projecting 8% growth. The stock is part of the Top 15 Utilities portfolio.


WEC Energy Group ($65; WEC) has not missed a dividend payment since 1942 and has raised its dividend in 14 consecutive years. Per-share profits are projected to rise 5% to 7% in 2017, consistent with the company's long-term expectations. Management expects dividend growth to mirror profit growth over time.

The company runs electric and natural-gas utilities in Wisconsin, Michigan, and Illinois. The stock has delivered a total return of 13% this year, pushing WEC's trailing P/E to 21, above its five-year median of 19 but roughly in line with the sector median. Yielding 3.2%, WEC is a member of the Top 15 Utilities portfolio.

TOP 15 UTILITIES PORTFOLIO
Indicated
Dividend
($)
Yield
(%)
3-Year
Average
Yield
(%)
3-Year
Annualized
Dividend
Growth
(%)
Payout
Ratio
(%)
Year-
To-Date
Total
Return
(%)
----- P/E Ratio -----
-------- Quadrix Scores --------
Company (Price; Ticker)
Trailing
Current
Year
Momen-
tum
Value
Overall
EQT Midstream Part.
($74; EQM) *
3.74
5.1
3.6
23
NM
0
14
14
56
86
94
Star Gas Partners
($11; SGU) *
0.44
4.0
4.6
8
NM
4
44
20
36
43
49
Great Plains Energy
($31; GXP)
1.10
3.6
3.7
6
65
15
18
18
48
62
41
WEC Energy Group
($65; WEC)
2.08
3.2
3.4
10
68
13
21
21
39
54
56
Eversource Energy
($61; ES)
1.90
3.1
3.2
7
61
14
20
20
43
57
51
DTE Energy ($109; DTE)
3.30
3.0
3.3
6
59
13
20
20
72
58
75
Portland General
($46; POR)
1.36
2.9
3.1
5
61
8
21
21
67
57
58
CMS Energy ($47; CMS)
1.33
2.8
3.1
7
66
16
23
22
59
50
61
Sempra Energy
($117; SRE)
3.29
2.8
2.8
7
61
18
22
22
86
61
77
Edison International
($79; EIX)
2.17
2.7
2.7
14
51
11
19
19
61
60
70
NextEra Energy
($147; NEE)
3.93
2.7
2.9
10
60
25
23
22
75
49
74
NiSource ($26; NI)
0.70
2.7
2.9
(12)
58
21
22
22
64
63
65
Vectren ($66; VVC)
1.68
2.6
3.3
5
62
29
24
25
83
41
76
Atmos Energy
($85; ATO)
1.80
2.1
2.5
7
49
17
23
24
65
39
60
UGI ($48; UGI)
1.00
2.1
2.3
8
44
5
21
21
38
59
47
Top 15 Utilities
average
3.0
3.1
7
59
14
22
21
59
56
64
S&P 1500 utilities
average
3.0
3.3
6
61
16
21
21
54
54
54
Note: Quadrix scores are percentile ranks, with 100 the best.  * Master limited partnership (MLP).  NM Not meaningful because MLPs' tax treatment makes it practical to distribute far more of their earnings than most traditional stocks.

 


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