One of the Best Remaining Utility Dividends

By Chad Henage - September 15, 2012 | Tickers: DUK, EXC, SO | 0 Comments

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I'll be the first to admit, if there is a bubble in the market when it comes to dividends, it's probably in the utilities sector. Two of the most popular utilities I hear constantly recommended are Duke Energy (NYSE: DUK) and Southern Co. (NYSE: SO). There is just one big problem. Both of these companies have serious challenges when it comes to maintaining their current payouts. Investors looking for a better yield and a safer payout should probably look elsewhere. This is what leads me to suggest Exelon (NYSE: EXC).

Exelon is still a well-known utility, but for some reason the company doesn't get mentioned as much as Duke or Southern. A part of the reason could be the latter two have a history of increasing their dividends, and Exelon has kept its dividend the same for several years now. However, investing through the rear-view mirror is rarely profitable, and from what I've seen Duke and Southern have issues that Exelon does not. Let me compare the three for you and I think you'll see what I mean.

Duke Energy – Anemic Growth and a Negative Payout Ratio:

Duke Energy at current prices yields about 4.7%. That's not a bad yield at all in today's environment, but the company's growth rate is anemic at best. Investors might expect that their merger with Progress Energy will improve earnings, but I think it could actually work the opposite way. I recently wrote about this, and found that where Duke was strong Progress was weak. For instance, while Duke showed a small increase in revenue, Progress saw a decrease in revenue. Duke showed interest expense jump 14% and Progress showed this cost increasing 7.41%. Duke has been running a negative payout ratio for the last four quarters, and for that matter the payout ratio has been negative for the last few years. With the stock trading for over 15 times earnings, anemic growth expected, and a consistently negative payout ratio, it is a stock I would avoid.

Southern Co. - Expensive and a 247% Payout Ratio:

Southern Co. is in a similar situation to Duke. The company saw revenue decrease 7.5% in their most recent quarter, and their payout ratio situation is only slightly better than Duke. Southern Co. generated about $129 million in free cash flow and paid $318 million in dividends on average in the last four quarters. When a company has a 247% payout ratio that should be a red flag to investors. This high ratio is not an aberration, as each of the last three years the company has paid more in dividends than they produced in free cash flow.

In addition, over the last few years Southern Co. has also seen an increase of over $4 billion in long-term liabilities. The company's balance sheet is starting to show the strain of this high payout ratio. Cash and investments decreased almost $700 million and long-term debt rose about $700 million. While Southern Co. is expected to grow faster than Duke at about 5%, the stock is also priced at about 17 times forward EPS projections. This means Southern Co. is more expensive, has a lower yield (4.28%), and is only slightly worse off than Duke with their payout ratio. This is another situation where I don't see the attraction to the shares.

Exelon – Higher Yield & Reasonable Payout History:

Exelon sounds a bit different compared to the other two. The company's merger with Constellation Energy should begin to pay dividends. Constellation Energy operates BG&E and this division of Exelon won a rate case that will allow the company to raise its electric base rate by $151 million and its gas base rate by $53 million starting in February 2013. With BG&E generating less than half the profit of Exelon's two other utilities, this increase should help tremendously. The company's availability and demand numbers also spell increased rates in the future as well. Nuclear operations showed a 93.4% capacity factor versus 89.6% last year. The company's fossil fleet demand forced outage rate was 4.5% versus 5% last year. Hydroelectric availability was up to 96.2% versus 93.4% last year, and wind fleet energy capture was 95% versus 93% last year. With every significant sector showing decreased availability and increased efficiency, it's clear that demand is up. When demand increases and efficiency is already nearing its maximum rates in theory should rise. Where there is a significant separation between Exelon and the other two utilities, is in their financials.

Even in this transition period in the merger with Constellation, the company is taking positive steps to increase profitability in the future. The company completed a debt exchange for $700 million where notes at 7.6% were exchanged for a mixture of notes at 4.25% and 5.6%. This should help the company's balance sheet, and improve earnings by reducing interest expense. In addition, the company shows significant operating cash flow with over $2.38 billion in cash flow in the recent quarter. In the current quarter their free cash flow payout ratio was negative, but history tells us that Exelon will work its way through the merger and get the payout ratio back to where it should be. In the last three years, Exelon's average payout ratio has been 75.08%.

Conclusion:

What's the biggest difference between Exelon, Duke, and Southern Co.? Exelon's current yield is over 5.7%, versus 4.7% at Duke, and about 4.3% at Southern Co. In addition, Exelon sells for about 13 times forward estimates, which is cheaper than either of their more well known competitors. Given the negative payout ratio at Duke, the over 200% payout ratio at Southern Co., or the 75% historical payout ratio at Exelon the choice is clear. Exelon stock is cheaper, pays a significantly higher yield, and over time their consistently reasonable payout ratio should give investors confidence in the dividend.

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