DUK - Duke Energy: High Quality Income At The Right Price

2023-03-31 08:15:00 ET

Summary

• There's nothing boring about Duke Energy's steady results and moat-worthy positioning as a leading utility.
• It's making strong inroads into renewable energy and enjoys jurisdictions with constructive rate-setting legislation.
• I also highlight the dividend, balance sheet, valuation, and other important points.

It's been a while since I last visited Duke Energy ( DUK ) here back in January, and it seems like a year has passed considering everything that's unraveled in the economy since then.

At the time, I found DUK to be too expensive considering that it was yielding under 4% and recommended that readers wait for a +4% yield. It appears that the market has validated my thesis, as the stock has dropped by 8% since my last piece, underperforming the 1% rise in the S&P 500 ( SPY ) over the same time.

With the market now appearing to take on more risk, I revisit DUK by highlighting recent developments and provide an updated valuation and recommendation, so let's get started.

Why DUK?

Duke Energy is a large electric power holding company that's also among the Fortune 150. It has operations in six states across the U.S., serving 8.2 million customers and collectively owns 50,000 MW of energy capacity. Over the trailing 12 months, DUK generated $28.3 billion in total revenue.

With stable and steady income-producing vehicles such as utilities, it's generally a good idea to purchase them when they are trading in the bottom half of their 52-week range, as the market price can swing violently one way or the other within a short time frame. This appears to be the case now, as DUK is now well within the bottom half of its trading range over the past 12 months, and sports a respectable 4.2% dividend yield.

While DUK may seem like a boring utility, there's nothing boring about potential returns, as management is guiding for 7% adjusted EPS growth this year, to $5.65 per share at the midpoint. This fits within management's long-term annual growth target in the 5% to 7% range through 2027.

This is driven on the back of constructive regulatory environments in Florida, as well as an improving outlook in North Carolina, which is Duke's largest service territory. This includes favorable legislation that allows for multi-year rate plans, including support for Duke's expected capital spending on renewable energy.

Renewables are expected to be a meaningful growth driver, as they don't come with the input costs and commodity price swings that are associated with traditional fossil fuels. Management highlighted recent legislative breakthroughs in North Carolina on this front, as noted during the recent conference call :

We've reached a significant milestone in our clean energy transition. On December 30, the North Carolina Utilities Commission issued an order adopting an initial carbon plan. The order recognizes the value of an all-of-the-above approach to achieving carbon reduction targets in a manner that balances affordability and reliability for customers.

The near-term action plan provides approval of 3,100 megawatts of solar and 1,600 megawatts of storage as well as transmission upgrades to support the integration of these renewable resources. And as part of an orderly transition out of coal by 2035, the commission supported planning for approximately 2,000 megawatts of new natural gas generation to maintain reliability.

Moreover, DUK recently announced this month that it's started operations at the largest solar power plant ever, the 250 MW Pisgah Ridge Solar project in Navarro County, Texas. Encouragingly, DUK has locked in a 15-year virtual power purchase contract with three companies on this site, one of which includes pharmaceutical giant Charles River Laboratories ( CRL ).

Meanwhile, DUK maintains a sound BBB+ rated balance sheet and enjoys a clear line of sight with regards to its capital, as management noted that "90% of the electric investments in our capital plan are eligible for modern recovery mechanisms". Management also expects the FFO to Debt ratio to return to its 14% long-term target as it recovers deferred fuel balances over the course of the year.

Importantly, the dividend remains well protected by a 71% payout ratio (based on the midpoint of 2023 earnings guidance), and DUK has grown the payout for 11 consecutive years. At the current dividend rate of 4.2% combined with management's long-term 5% to 7% annual EPS growth, investors could see around 10% annual returns going forward. This is slightly higher than the long-term CAGR of the S&P 500, with a far higher yield and more stability coming from this moat-worthy utility.

As such, I find DUK to be reasonably attractive at the current price of $96 with forward PE of 17x. Analysts have a consensus Buy rating on the stock with an average price target of $107 , translating to a potential 16% total return over the next 12 months.

Lastly, more conservative income investors may want to consider the preferred stock ( DUK.PA ). This preferred issue comes with an immediate higher yield of 5.6%. While it does carry a slight premium to liquidation preference and has a call date of 6/15/2024, DUK may choose not to call it at that time considering the current high interest rate environment.

Investor Takeaway

All-in-all, Duke Energy has hit my price target on recent share price weakness. It's a well-run and reliable utility that stands to benefit from its investments in renewable energy, of which it's making meaningful inroads. With potential annual returns in the 10% range, DUK offers a mix of higher yield and stability compared to more volatile sectors in the market. As such, conservative income investors may want to give DUK or its preferred issue, DUK.PA, a hard look at current prices.

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