Is Duke Energy The Next Dividend Blowup?

By Chad Henage - May 23, 2012 | Tickers: LNT, ED, DUK, SO | 0 Comments

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Duke Energy (NYSE: DUK) has gotten a lot of respect recently for its dividend payments and consistency. I've personally talked to investors who believe Duke's dividend is about as solid as they come. I'm sure the expectation that Duke will continue to raise their dividend, has a lot to do with the over 12% increase in the price of Duke shares in the last year. Investors will bid up shares of utilities on the expectation of continued dividend increases. There is just one problem, investors don't seem to remember Duke's history.

Utilities get a lot of respect and adoration in today's market, for their low volatility and relatively high yields. When you look at the following, it's obvious that utilities have been in favor.

Given that the S&P 500 has lost 1.69% in the last twelve months, these types of companies have clearly been outperforming the market. Many investors probably believe that investing in utilities is safe, and their dividends are consistent. This however is not always the case.

When it comes to paying dividends, even utilities have to make enough money to afford their payouts. It might surprise investors to know that Duke has actually shown negative free cash flow for the last three years. This brings into question the company's ability to maintain their existing dividend. Look at Duke's negative free cash flow versus their dividend: 

So essentially for the last three years plus one quarter, the company paid out dividends that the company did not have the money for. Where did the money come from? The company took on $2.5 billion in long-term debt during this same time frame. This is simply not sustainable, as the interest to carry this additional debt has jumped 10% in the last four quarters. In June 2011, the company spent about $203 million a quarter in interest, by March 2012 that number was up to $224 million. This means Duke has to make at least $560 million a quarter just to cover dividend payments and interest. In plain english, the company needs to either cut back on capital expenditures, or cut the dividend.

As you can see, Duke's cash flow situation is not exactly safe. If investors want to know what to expect from the dividend in the future, I'll just point out that Duke's streak of dividend increases only stands at 5 years. The last time the dividend was cut was 2006. Prior to that, the dividend wasn't increased at all for 5 straight years. If I'm a Duke investor, I would be more worried about whether Duke can maintain its current dividend. Just because the company is a utility doesn't mean the dividend can't be cut, it has already happened to Duke shareholders before. Based on the company's cash flow and capital expenditures, without a major change, a second dividend cut seems almost certain.

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