This article is about Duke Energy (DUK) and why it’s a buy for the income investor. Duke Energy is one of the largest electric utilities in the United States with over 7 Million customers.
Fundamentals of Duke Energy will be reviewed in the following topics below The Good Business Portfolio Guidelines, Total Return and Yearly Dividend, Last Quarter’s Earnings, Company Business and Takeaways And Recent Portfolio Changes.
I use a set of guidelines that I codified over the last few years to review the companies in The Good Business Portfolio (my portfolio) and other companies that I am taking a look at. For a complete set of the guidelines, please see my article “The Good Business Portfolio: Update To Guidelines and July 2016 Performance Review“. These guidelines provide me with a balanced portfolio of income, defensive, total return and growing companies that hopefully keeps me ahead of the Dow average.
Good Business Portfolio Guidelines.
Duke Energy passes 9 of 11 Good Business Portfolio Guidelines. These guidelines are only used to filter companies to be considered in the portfolio. Some of the points brought out by the guidelines are shown below.
Duke Energy has a dividend yield of 4.2% which is well above average for the market. The dividend has been increased for 9 of the last 10 years and its dividend is safe meeting my dividend guideline. Duke Energy is therefore a great choice for the income investor since the dividend almost increases each year. The average 5 year earnings payout ratio is high at 78% leaving cash flow for expansion with the dividend being very safe.
Duke Energy is a large-cap company with a capitalization of $57.6 Billion. The large size of Duke Energy gives it the muscle, plus its cash flow to increase the business going forward. Duke Energy 2017 estimated total yearly cash flow at $3.15 Billion is strong allowing the company to have the means for company growth and paying a growing dividend.
I also require the CAGR going forward to be able to cover my yearly expenses. My dividends provide 3.2% of the portfolio as income and I need 1.9% more for a yearly distribution of 5.1%. The three-year forward CAGR of 2.0% (S&P Capital IQ) does not meet my requirements. This low CAGR is very conservative when you consider the forward economy growing strongly as President Trump lowers the tax rates and brings foreign earnings back to the United States. Duke Energy projects a earnings growth rate of 4-6% as shown in the business overview section graphic below.
Looking back five years $10,000 invested five years ago would now be worth over $16,400 today. This makes Duke Energy a fair investment for the total return investor looking back and a good investment for the income investor.
Duke Energy S&P Capital IQ rating is three stars or hold with a target price of $76.0. Duke Energy price is presently 9% above the target. Duke Energy is over priced at the present price but is a good investment for the long term income investor who wants above average income and fair growth.
One of my guidelines is would you buy the whole company if you could, the answer is wait and see as the company gets more into renewable energy. The Good Business Portfolio likes to embrace all kinds of investment styles but concentrates on buying businesses that can be understood, makes a fair profit, invests profits back into the business and also generates a fair income stream. Most of all what makes DUK interesting is the increasing economy growth and the hope of reduced taxes. The projected mix to more renewable energy is shown in the graphic below from the fourth quarter earnings slide review.
Source : DUK Fourth quarter earnings slides
Total Return And Yearly Dividend
The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. Duke Energy total return underperforms the Dow baseline in my 51.5 month test compared to the Dow average. I chose the 51.5 month test period (starting January 1, 2013 and ending to date) because it includes the great year of 2013, and other years that had fair and bad performance. The fair total return of 48.15% makes Duke Energy a investment for the income investor providing a steady growing income that almost matches the market average total return. Duke Energy Has increased its dividend for the past 9 of 10 years and presently has a yield of 4.2% which is well above average for the income investor.
DOW’s 51.5 month total return baseline is 56.08%
51.5 Month total return
Difference from DOW baseline
Yearly Dividend percentage
As seen in the 5 year price chart below Duke Energy price chart moves up and to the right in a slow steady pattern which shows continuous growth but is subject to interest rate changes.
Last Quarter’s Earnings
For the fourth quarter on February 16, 2017 Duke Energy reported adjusted earnings that meet expected at $0.81. This was a fair report with bottom line and top line reasonably meeting expected numbers. Management guided earnings for 2017 at $4.50-$4.70. The next earnings report will be out in mid May 2017 and is expected at $1.07 compared to last year at $1.13 showing continued growth after adjustments for discontinued operations.
Duke Energy is one of the largest electrical energy supplier in the United states. The company grows by adding new customers and buying bolt on companies with its good cash flow.
As per Reuters ” Duke Energy is an energy company. The Company operates through three segments: Electric Utilities and Infrastructure; Gas Utilities and Infrastructure, and Commercial Renewables. The Company operates in the United States through its direct and indirect subsidiaries. The Electric Utilities and Infrastructure segment provides retail electric service through the generation, transmission, distribution and sale of electricity to approximately 7.5 million customers within the Southeast and Midwest regions of the United States. The operations include electricity sold wholesale to municipalities, electric cooperative utilities and other load-serving entities. The Gas Utilities and Infrastructure segment serves residential, commercial, industrial and power generation natural gas customers. The Commercial Renewables primarily acquires, builds, develops and operates wind and solar renewable generation throughout the continental United States.”
Duke Energy is growing its business with good organic growth and increases from bolt on companies as seen in the quote below from the fourth quarter earnings call.
From the February 16, 2017 earnings release Lynn Good (Chairman and Chief Executive Officer) said.
“2016 was a transformational year for Duke Energy as we acquired Piedmont Natural Gas and exited our International business, positioning the company for more consistent earnings and cash flow growth,” said Lynn Good, Duke Energy chairman, president and CEO. “We continue to advance our long-term growth strategy to modernize the energy grid, generate cleaner energy and expand natural gas infrastructure. Our employees’ commitment to industry-leading operational and safety performance, combined with our unwavering focus on cost management, enabled us to achieve financial results at the high end of our guidance range.
Our strategy is producing results. By investing in infrastructure our customers value and delivering sustainable growth for our investors, we are confident we will achieve strong results in 2017 and beyond.”
As seen in the graphic From the February 2, 2017 fourth quarter earnings slides Over all Duke Energy is a good business with 8%-10% CAGR projected growth as the need for more electrical energy will be needed as the economy grows going forward. The good cash flow provides Duke Energy the capability to continue its growth by buying bolt on companies and adding additional new customers and expanding its service areas.
Source : DUK Fourth quarter earnings slides
As seen in the graphic From the February 16, 2017 fourth quarter earnings slides DUK’s business will grow as more and more use of electricity grows with the economy. This shows they are meeting their goals for continued year over year growth.
Source: Fourth quarter earnings slides
Also as a tail wind we have President Trump who wants to lower tax rates and bring back the foreign earnings to the United States. As the tax rate is lowered earnings of Duke Energy business should increase with lower rates than the present 35%.
The economy is showing moderate economic (about 2.3%) growth right now and the FED has raised rates in March 2017 with future rate increases dependent on the United States economy. The FED projects for 1-2 more increases in 2017. I feel when it does raise rates it will be less, maybe just one more, they don’t want to trigger a slowdown in the economy.
Takeaways and Recent Portfolio Changes
Duke Energy is an investment choice for the income investor with its above average yield of 4.2% and its average total return compared to the DOW average. Duke Energy will not be considered by The Good Business Portfolio until better growth at around 5% begins to show as projected by management. If you need more steady income in your portfolio then the energy supply sector using Duke Energy may be the company for you.
Trimmed Harley Davidson (HOG) to 3.8% of the portfolio. Growth looks likely to be negative again this year. A great company but competition is hurting earnings and are projected to be less than last year. Earnings reported on April 18 beat expected by $0.03 at $1.05 but much less than last year of $1.36. Revenues were also down 15.8% at $1.33 Billion year over year, not a good report. Selling of covered calls is making money while the portfolio trims this position.
Increased position of Omega Healthcare Investors (OHI) to 5.84% of the portfolio. I wanted a little more income and a dividend increase is coming in mid April.
Trimmed Boeing (BA) from 10% of the portfolio to 9.4%. Great Company but you have to be diversified.
Sold covered calls May 5th $58.0 strike price on a portion of the HOG position to make some money while I wait for Harley sales to start to grow again.
Sold covered calls April 28th $59.0 strike price on a portion of the HOG position to make some money while I wait for Harley sales to start to grow again.
Sold covered calls April 20th $58.5 strike price on a portion of the HOG position to make some money while I wait for Harley sales to start to grow again.
Added to position of Ingersoll-Rand (IR) now at 4.1% of the portfolio a full position. S&P recently raised IR target price to $86 from $80.
Added to position of Digital Reality Trust (DLR) now at 1.3% of the portfolio. I feel the computer industry facilities business has nowhere to go but up and DLR pays an above average dividend. I wrote an article on Digital Reality Trust this year if you are interested. This is another specialty REIT in a growing sector.
The Good Business Portfolio generally trims a position when it gets above 8% of the portfolio. The four top positions in The Good Business Portfolio are, Johnson and Johnson (JNJ) is 8.0% of the portfolio, Altria Group (MO) is 8.0% of the portfolio, Home Depot (HD) is 8.2% of portfolio and Boeing is 9.4% of the portfolio, therefore all four are now in trim position.
Boeing is going to be pressed to 10% of the portfolio because of it being cash positive on 787 deferred plane costs at $251 Million in the fourth quarter a $64 Million increase from the third quarter. The fourth quarter earnings were good with Boeing beating the estimate by $0.14 at $2.47. S&P Capital IQ also raised its one year target to $191. First quarter earnings will be out April 25 and I expect a beat of $0.10 at $2.10.
JNJ will be pressed to 9% of the portfolio because it’s so defensive in this post BREXIT world. Earnings in the last quarter beat on the top and bottom line but Mr. Market did not like the growth going forward. JNJ is not a trading stock but a hold forever, it is now a strong buy as the healthcare sector is under pressure to reduce medical costs.
For the total Good Business Portfolio please see my article on The Good Business Portfolio: 2016 4th-Quarter Earnings and Performance Review for the complete portfolio list and performance. Become a real time follower and you will get each quarters performance after the earnings season is over.
I have written individual articles on JNJ, EOS, GE, IR, MO, BA, PEP, Omega Health Investors, Texas Instrument (TXN), Digital Investors Trust (DLR) and Home Depot (HD) that are in The Good Business Portfolio and other companies being evaluated by the portfolio. If you have an interest please look for them in my list of previous articles.
Of course this is not a recommendation to buy or sell and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account and the opinions on the companies are my own.
Disclosure: I am/we are long BA, JNJ, MO, HD, OHI, HOG, IR, TXN, DLR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.