Today we return to the high-dividend, low-volatility portion of our portfolio in our "balanced barbell" approach.
We have discussed this strategy over the past few months and have recommended using these kinds of stocks as a balance to more dynamic names that have greater potential for appreciation, stocks that have also tended to have more day-to-day volatility. This balance has been a powerful strategy in the current market.
Today we focus on Duke Energy (DUK). The company has a solid business franchise that should provide stability, attractive income and modest appreciation over time. Despite a recent media black eye concerning management changes following its large acquisition of Progress Energy, we believe its merits warrant a hard and favorable look.
As a result of its purchase of Progress, Duke is now the largest regulated utility. More than 90% of its earnings come from operating highly regulated electrical generating plants and transmission systems. The earnings, cash flows and dividends from these operations are higher than utility averages.
For the most recent quarter, Duke reported better-than-expected earnings of $1.02 per share, compared with a $0.97 consensus. Management re-affirmed the yearly guidance of 3% to 5% earnings growth. Management also confirmed that the Duke-Progress merger synergies were also tracking to plan.
Duke has recently been trading at a discount to the group because of the unexpected resignation of Progress' CEO and several of his top lieutenants who were supposed to lead the newly combined entity. Instead, Duke's former CEO stayed on as CEO. The stock is currently trading at a discount of 1 price-to-earnings multiple point to the leading regulated utilities group because of 1.) these management changes, 2.) fears of a regulatory backlash, and 3) the dirty laundry-type disclosures that the Progress CEO and Duke CEO have each made during their public depositions with the regulatory bodies that are reviewing the CEO change.
Duke typically trades at a 10% to 15% premium to the group.
While there might be some short-term discomfort in holding the name, we believe Duke is a solid addition to a diversified, higher-dividend-oriented portfolio. The unexpected management change still leaves the combined utility in the hands of seasoned operators who have a long-term track record of both merging utilities and operating power plants.
The stock currently has an above-average 4.5% dividend yield and a strong investment-grade credit rating of A. For the past five years, Duke has consistently grown revenue by 4.5% per year and earnings 7% per year.
The company consistently raises its dividend and has a sound balance sheet and a payout ratio that can well afford the dividend. We expect Duke to continue to grow dividends in line with its long-term growth rate at 2% to 5% per year due to acquisitions, margin improvements and continued market growth.
The stock should also provide some capital appreciation potential, since the current P/E ratio of 15.3 is below the peer average of 16.3, although Duke has historically traded at a premium to the group.
As much as we like the stability of return provided by lower-volatility, higher-dividend-paying blue chips, we recognize that the market's hunger for these characteristics has driven up utilities to very high relative price levels. If and when the group experiences some P/E contraction, Duke should be more protected than most because of its current discount.
With that caveat about the group, we believe that Duke should continue to be an all-weather keeper.