Sector Overview – Utilities

utilities

The utilities sector has seen a fair bit of correction as investors have sold off this bond-substitute as the interest rate jitters took hold of emotions. The Utilities SPDR ETF (XLU) is down approx 9% YTD. This has pushed the valuation to attractive levels for some utilities and I am looking to initiate positions in this sector. Regular readers of this blog are familiar that I recently sold my position in a utilities ETF (BMO Utilities ETF – ZUT.TO) that had exposure only to 12 companies and all exposed only to the Canadian economy. There were a few other reasons for selling that ETF – one of the main ones was the fact that I wanted dividend growth from my holdings. In my quest to narrow down utilities and find one to invest in, I have been doing some research and decided to share the details on how I am narrowing down my pickings. This way, you can see how I am picking my investments. Feel free to share your thoughts and comments below.

Note that the tables below show the data that interests me. The columns are extracted from Dave Fish and Michael Weber’s CCC lists. Other investors may give more weight to other metrics (including myself). While this exercise is supposed to help me narrow down companies to research, I may go back and revisit the whole list and start looking into researching even if it failed on one criterion which caused it to get dropped from the list.

Terminology

Chowder Rule: Named after “Seeking Alpha” member Chowder, this is a method of identifying candidates for purchase based on a combination of yield and (5-year) dividend growth rate. When the sum of these elements is above 12%, the company presents an attractive entry point (8% for utilities). When the figure is above 8%, an existing holding is still considered worthy of being retained. Caution: This ‘Rule” is intended to be used in conjunction with measures of quality, such as high marks for safety and financial stability, as specified by organizations such as Value Line or Morningstar.

Est 5-yr Growth: is the expected earnings growth rate for upcoming five years, according to analysts.

Confidence Factor: indicates the confidence in continuation of dividend increases – see Dave Fish’s CCC list for scoring system details in the ‘Notes’ tab. Numbers range from 1 to 102.

Step 1 – Starting List

I started off with Dave Fish’s CCC list that contains data for all dividend growth companies that have raised dividends for atleast 5 years. I have also added the utility companies in the Canadian market taken from the Canadian All-Star List maintained by Michael Weber. From these two lists, we get 62 companies in the utilities space – which is a huge list and needs to be trimmed and narrowed down for further research.

In the 56 companies from Dave Fish’s CC list, there are 17 Diversified Utilities (electric & gas), 12 Electric-Only, 16 Gas-Only, 9 Water Utilities, and 2 Other.

In the 6 companies from Michael’s All-Star list, there are 4 Diversified, 1 Electric-Only, and 1 Other

allutes-ccc

Total Companies: 62

Step 2 – Duplicates & Small Caps

There is one duplicate in the list – Brookfield Infrastructure Partners LP (BIP, BIP.UN.TO) – so I remove the Canadian listed duplicate.

In the Canadian list, I remove Atco Ltd (ACO.X.TO) – which for most purposes is the same as Canadian Utilities (CU.TO) except for higher exposure to Atco Structures & Logistics – see the Corporate Structure here.

By investing in utilities, I am looking for income stability and in the past I have normally stuck with larger companies for most of my investing needs. While the utilities sector is probably different – esp since its a regulated industry, I still remove small caps from consideration. Considering only Mid Cap and over ($2B+) companies results in 15 entries being removed.

utes-midcap+

Total companies remaining: 45

Step 3 – Chowder Rule

The Chowder Rule normally states that a good opportunity exists in companies which have a Chowder value of 8% or higher. Considering that we are in an environment where getting any yield is hard and prices have been driven up, I decided to relax this rule from 8% to 7%. Even after relaxing the rule to 7%, we lose some high quality large cap companies that are popular with most dividend growth investors such as Consolidated Edison (ED), Duke Energy Corp (DUK), SCANA Corp (SCG), PPL Corp (PPL) etc. Nevertheless, I remove them from the list.

chowder7+

Total companies remaining = 30

Step 4 – Payout Ratio

I remove companies with extremely high & unsustainable EPS payout ratios. Instead of simply removing based on a flat number of payout ratio, I also take into account what the expected EPS growth over the next five years according to analysts. Here I remove APU, which has a payout ratio of 371% and an EPS growth estimate of 2.2%; BIP has payout ratio of 175% and EPS growth est of 0.6%.

Two other candidates for removal are Dominion Resources (D) and Southern Company (SO). Dominion has 103% payout ratio, but has a decent EPS growth rate estimate of 5.9%. However, it appears that the dividends have also been growing at the same rate (see the dividend growth rates (DGR)), so I expect those dividends to slow down considerably over the coming years unless the EPS rises faster. Dominion also seems to be most overvalued compared to the Graham Number values. Southern Company has 92% payout ratio and EPS are expected to grow 3.3% for next five years. Again, this is in the ball park of the DGRs for SO. The good thing about SO is that it yields almost 5%, so its unrealistic to expect faster DGR. I have decided to leave D and SO in the list for now.

utes-sustpayout

Total companies remaining = 28

Observations

Some notes from the list of 28 companies:

  • The longest dividend increase streak is Canadian Utilities (CU.TO), with Fortis Inc (FTS.TO) coming a close second.
  • Southern Company (SO) and Brookfield Renewable Energy (BEP.UN.TO) have the highest yield (~5%).
  • Wisconsin Energy (WEC) and CMS Energy (CMS) take the crown for best Chowder Rule numbers (~20%). Both payout about 2/3 of their earnings in dividends (~3.5% yield), have good EPS earnings growth estimate of 5.8% and 6.7% respectively.
  • Lowest yielding company is ITC Holdings (ITC) at 1.8%, but also has the highest EPS growth rate estimate at 11.9%
  • Lowest EPS growth rate estimate goes to CenterPoint Energy (CNP) at 1.9%
  • As per the Graham Number values, Dominion (D) is the most overvalued and Westar Energy (WR) is the most undervalued.
  • Confidence factor: Highest for NextEra Energy (NEE) and lowest for Dominion (D).
  • All things considered, I think its safe to say that Dominion (D) should be dropped from the list. I will be looking into the rest of the companies and look for qualitative aspects and advantages they may enjoy over peers.

What are your thoughts on the process and the shortlist? Are there any particular utility companies that I need to pay attention to – either from the final list of 28 or from the ones that were removed? Share your thoughts below.

Full Disclosure: None. My full list of holdings is available here.

Further Reading:

39 thoughts on “Sector Overview – Utilities

  1. Bernie says:

    Very interesting article! I screen for dividend growth candidates in a similar fashion. Being 64, retired and only accumulating for about 3 to 4 more years I tend to place a greater importance on yield and dividend growth. I won’t consider any companies under 2.8% yield.

    I’ve dabbled a bit with back testing of David Fish’s year end CCC lists. I’ve found if I screen for the criteria shown below the top 15 stocks that pass tend to outperform the others in total return, but not necessarily DGR, in the year to follow:
    Yield >/= 2.8%
    Payout Ratio (EPS) 500K + no OTC
    Qtly + Mnthly payers only
    US, UK + Bermuda domicile only
    No “being acquired” stocks
    No MLPs, tobacco or firearm stocks
    MR% >/=5%
    DGRs (1,3,5,10 Yr) >/=5%
    Chowder # (3-Yr) >11.5%, Util >/=8%
    Streak >/=10 yrs
    Ranked by yield

    • Thanks for sharing your screener, Bernie. Really appreciate it as it gives me perspective on what folks are looking at when evaluating stocks.

      Why pick a starting yield of 2.8%? Ive seen ppl pick round numbers like 3% but am wondering if you pick has some reasoning behind it. Anything to do with the bond yields?

      Best
      R2R

      ps: Also, what is the tax situation with Bermuda domiciled equities? Do you get taxed when held in RRSP account?

      • Bernie says:

        R2R,

        I aim for a overall portfolio yield of 4% to 5%. As you know when stock prices rise their yields tend to drop, depending on dividend raises of course. Lower yielders tend to have higher DGRs than higher yielders so I don’t mind including the odd low yield stock in my portfolio so long as my overall yield is acceptable. I believe the 2.8% min. originated with Bob Wells (Seeking Alpha).

        Bermuda domiciled equities do not incur withholding taxes in RRSPs. There are quite a few companies based there for tax reasons, BIP & BEP for example. I own BIP-UN.TO.

  2. Very interesting article and approach. I like the idea of doing sector specific analyses. I might just adopt that in future 🙂

    APU is an MLP and a holding in DivGro. I wouldn’t screen with EPS payout ratio for MLP stocks (or REITs). Both types of stocks have to pay out most of their earnings as dividends, which skews the picture. If you DO look at that stat, I would look at historical values to put the current value in perspective.

    APU has done well for me, with total returns of 22% (or 18% annualized).

    Cheers
    FerdiS

  3. R2R,

    Nice list of companies you have there. I still view most of them as expensive or fairly valued at best. I want to own several of those listed though at the moment the only listed stock I hold is SO. WEC seems like a great company but the yield isn’t quite there for me.

    I’m guessing some of this is relevant to age. You are young yet and obviously focused on div growth. I’m retired, and have a slightly different perspective. Dividend growth is wonderful, but I need to add in a little high yield for current income. Equally as important is that the higher yield be relatively safe and stable. Thus, I own AT&T and SO. Neither is a screamer when it comes to dividend growth, but I feel like I can count on the dividends.

    I would not consider dropping SO from my list, but that’s due to my situation and not a criticism of your viewpoint. I have other stocks that help more in the area of dividend growth. All in all, I seek a blend of higher yield and dividend growth. I enjoyed your article.

    Steve

    • Glad you enjoyed the article, Steve.

      I think your reasoning makes good sense. I think you are right on the money with what you want out of your utility stocks – looking for secure consistent income in retirement. I think theres a place for utilities in everyone’s portfolio – whatever the age may be. I have held SO in the past – and before I dived back into it, I wanted to evaluate the whole sector carefully and see where things stand. All things considered, SO is a great company – even though the payout ratio is high. WEC is also a great pick. One company that stood out for me from this was NEE – I need to research more – and it looks like they are big players in renewable energy production (not sure what percentage of their business is in that segment). Still a lot of research left to be done before I can initiate a position in any of the stocks mentioned.

      Thanks for sharing your thoughts
      Best
      R2R

    • Bernie says:

      Dividend Gravy,

      “WEC seems like a great company but the yield isn’t quite there for me. ”

      I own WEC, the dividend growth has been very good. They recently announced an 8.3% dividend raise (effective Sep 1st) in conjunction with their TEG purchase.

      • WEC seems to have the best dividend growth rate compared to the rest of the peers. And with a starting yield of 3.5%, whats not to like?! I will definitely be taking a closer look at this company over the weekend

        R2R

      • Bernie,

        WEC has not escaped my notice. I’m just not overly excited about the current yield. I don’t know how much longer they will be able to continue the large dividend increases either. Last I looked, the TTM payout ratio was well over 60%. I have no idea though what their target payout is.

        So, I’m on the fence with this one. Great company, but I wonder if the time to buy has already passed. I be keeping any eye on it. Perhaps I’ll find an entry point I’m happy with.

        Steve

        • Just had a look at the investor presentations – looks like the company is targeting a payout of upto 65-70%, and the target eps growth rate according to the company is 5-7%. The payout ratio is close to the target – and looks like the dividend growth will slow down from the current highs.

          R2R

          • Bernie says:

            With two 8.3% increases in four quarters resulting in a 12.8% year over year increase I would say the odds of a dividend growth slow down are high.

          • Bernie says:

            I couldn’t resist. The following is a cut and paste from a Seeking Alpha article this evening…

            “1,000 investments in WEC and SPY 5 years ago would be worth 2089 (WEC) and 2079 (SPY) today.

            1000 investments in WEC and SPY 10 years ago would be worth 3314 (WEC) and 2117 (SPY) today.

            1000 investments in WEC and SPY 15 years ago would be worth 6888 (WEC) and 1893 (SPY) today.

            1000 investments in WEC and SPY 20 years ago would be worth 7000 (WEC) and 5542 (SPY) today.”

          • R2R and Bernie,

            I will assume that WEC’s dividend growth glory days are soon to be history. Instead I will consider the 5% earnings growth. If dividends grow along with earnings at 5%, that means I will need a minimum yield of 3% (Chowder Rule).

            If I want a decent margin of safety, I’m looking for a yield of 4% which would put the price at about $42. Not out of the realm of possibilities. I’m going to set up a price alert and will re-evaluate if it hits.

            Steve

          • Bernie says:

            The chowder rule or number is a guideline generally used by dividend growth investors in the initial stock screening process. Few use it in their sell criteria.

          • Bernie,

            “The chowder rule or number is a guideline generally used by dividend growth investors in the initial stock screening process. Few use it in their sell criteria.”

            In that I don’t own any WEC, that’s how I’m using the Chowder rule…. as an initial screen on the stock. Yes, I agree that using it for sell determinations is not generally done.

  4. I’ve had my eye on SO for a while now. It’s been battered down a bit by negative press and plant delays so that yield keeps getting more appealing. My favorite on the list may be PNY though. It has a fairly high initial yield at 3.6% and respectable dividend growth for a utility not to mention it has been very resilient to market down turns which preserves equity. Thanks for the list.

    • Thanks for the input Captain. I remember seeing PNY on your portfolio a while ago – and looks like a good dividend play in the gas sector.

      I have my eye on SO as well – its a solid company and the charts have exactly what I expect from utility stocks – slow growth over the years, and low volatility – good preservation of wealth and some decent income.

      cheers
      R2R

  5. Hey R2R,

    Thanks for sharing your method of analysis here. I’ve been a little interested in the utilities sector too, as it’s taken quite the beating the past month alone. Excited to see which company you choose on sticking with. Keep up the hustle bud.

    DB

    • You are welcome, DB. There are quite a few names that interest me, but a lot of them are really unfamiliar to me and I will need to read up and do some qualitative analysis to pick one (or two). I will be sure to share my findings once I decide.

      Best
      R2R

  6. Thanks R2R for this interesting article.
    Nice to see one of my holdings, ES, doing fairly well here.
    My other holding AVA was apparently dropped because of too small market cap?
    I hope to get my hands on a water utility at some point. And can’t forget CU either, damn those numbers look good again.

    • I was just looking into ES as I wasnt familiar with teh company and figured that it used to be NU. Looks like some great numbers and I will looking into it again this wknd. I am not familiar with AVA – will have to check up on it.
      CU sure is looking attractive after the pullback!

      Thanks for stopping by and sharing
      R2R

  7. Nice article and methodolgy R2R. I wrote a post last week that we are getting good opportunities in Bond Proxy investments, and those opportunities will likely get a lot better as global interest rates rise over the next 6 months. Thanks for sharing your screen and potentials. Have a great weekend buddy!
    -Bryan

  8. Roadmap,

    Interesting analysis! Which one do you really like? Also, I know quite a few that own SO as well. Funny that Dominion is the most overvalued… they are my gas provider, those punks! I like these analyses that you perform, very detailed.

    -Lanny

    • Lanny, glad you like it.

      I still like SO – even though the payout ratio is high and the earnings growth is low at ~3%. Looking at their long term chart – its as steady as it gets..exactly what I am looking for in a utility stock. Also, that 5%+ yield is enticing.

      Other ones I like in the list are: NEE (huge renewable component there), ES (diversified utils in the Northeast) and WEC (although the div growth will slow down in the coming years). Oh, one more – CU.TO – thats looking really good as well, albeit just a touch overvalued.

      cheers
      R2R

  9. R2R,

    Great and timely post! I need to add some utilities to round out my portfolio and your screening process will help immensely. While this sector does not see the same sort of growth that other sectors do, I like them because they sell something we all need. By doing our due diligence we can be sure to have a nice stable cash flow over the long-term.

    – HMB

    • Utilities in a way are great case study for dividend (growth) investing. The industry keeps chugging along year after year with steady increases, keeping up with inflation and providing a great source of income for shareholders.

      Looking forward to see which one you pick
      R2R

  10. Great article , R2R! Your analysis of the utilities sector was fantastic, and I do think they make a safe and reliable addition to a good dividend portfolio, even if the dividend growth tends to lag behind other sectors. The chances of people deciding to no longer use gas, electricity, or water is pretty much non-existent. Even with solar, wind, and nuclear, I’m sure the utilities will adapt and find a way to make those part of their”product line”.

    And I’ve never heard of the Chowder Rule before, but I like it. It gives you a good handle on a company’s valuation when the P/E ratio doesn’t tell the full story and things like DDM analysis fly over your mathematically challenged head. If nothing else, novices taking this into account can use it to help avoid making the mistake of using earnings to value REITs and MLPs.

    Sincerely,
    SRB–Angry Retail Banker

    • Aaand I spelled my user name wrong. I’ve got to stop typing these on a phone with a cracked screen.

      Sincerely,
      ARB (not SRB)–Angry Retail Banker

    • ARB,
      A few individual households may be able to get off the grid by generating their own electricity, but its still going to be a small segment of the population. Also, the industries and commercial sector will still want those services. As for other services such as water and gas, theres no escaping the fact that one needs the service of utility companies.

      Chowder rule is a good shorthand of filtering out and comparing companies. A combination of current yield and 5-yr dividend growth rate provides a single number which allows investors to compare two different companies. After that, one can dig in and explore the details. Its a neat little quick evaluation.

      Best wishes
      R2R

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