Finding value among US power generators

With its sector-leading margins, this US power generator merits attention after recent shares weakness.

Rodney Hobson is an experienced financial writer and commentator who has held senior editorial positions on publications and websites in the UK and Asia, including Business News Editor on The Times and Editor of Shares magazine. He speaks at investment shows, including the London Investor Show, and on cruise ships. His investment books include Shares Made Simple, the best-selling beginner's guide to the stock market. He is qualified as a representative under the Financial Services Act.

Two factors will work in favour of power generators in the United States: the continuing, if slightly sluggish, growth of the economy generally and the drive to reduce pollution in big cities through the switch to electric-powered vehicles. One power company worth revisiting is Duke Energy (NYSE:DUK).

It was founded more than 100 years ago and has grown into the largest electricity utility in the US, with 7.6 million electricity customers across the southeast and Midwest. It also has assets in Canada.

Regulated electricity still accounts for nearly nine-tenths of Duke's revenue, but its gas business is growing rapidly and now has 1.6 million customers. There is also a small renewable energy portfolio.

The group is highly profitable, with better operating margins than others in the sector in the US. The most recent quarterly results, covering the third quarter of 2019, showed revenue up 4.7% year-on-year while net income leapt 24% as net profit margins improved substantially. Its next results are due in mid-February.

One problem that has been hanging over Duke is the cost of cleaning up nine coal ash basins in North Carolina. Coal ash is the waste that is left after coal is burned. It comprises fine particles that can be carried in the air and can cause a health hazard as well as coarse material.

An agreement with state regulators and community groups signed this month involves closing the basins and transferring 80 million tons of ash to lined landfills but it does reduce the expected cost of up to $10 billion by $1.5 billion. Duke has already spent about $2.4 billion of this and the rest will be spread over 15-20 years, which is manageable.

I tipped the shares last May when they stood at $88, suggesting that they were worth buying below $90, with the downside limited to $83. In fact, the floor has moved up to $85.50 and the stock has been as high as $97, although it now stands at around $91.

The price earnings ratio is actually less demanding at 18.9 than it was in May and the yield is only slightly lower at 4.2%, still pretty good for such a solid investment and well above the industry average of 2.9%.

I pointed out that the group has a consistent record of paying quarterly dividends and it has raised the pay-out in each of the past 14 years, mostly by about 2%. In July 2018 it upped the rate of increase to 4%, more in line with earnings growth.

There was a fair chance that this level of increase would continue for the foreseeable future but, disappointingly, this has not proved to be the case. The 2019 increase, taking effect in September, was 1.75 cents, up 1.85%, taking the quarterly figure to 94.5 cents. I expect a higher percentage increase to be announced this summer.

Duke faces heavy capital investment in expansion and infrastructure, splashing out $37 billion over the next four years but with cash flow running at about $7 billion a year that is not a problem and it should mean earnings rising by up to 6% a year.

The shares have considerably underperformed two sector rivals, Dominion Energy (NYSE:D) and Southern Co (NYSE:SO), over the past 12 months with the gap widening noticeably over the past three months. This seems quite unjustified and it suggests that Duke is currently offering the best value at the moment.
Hobson’s choice: It wouldn’t be wrong to hold off and hope there will be another chance to buy below $90 but that opportunity may not arise. The stock is now worth buying up to $93.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.