3 Utilities You Want In Your Retirement Portfolio

Stable business models and high dividend yields make utilities perfect for retirees.
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Historically, utilities are known to be quite generous with their dividends. They tend to distribute roughly 50% of their available cash flow to their shareholders. This is the perfect type of business for dividend investors. Utility companies require large infrastructures and most of their capital projects are now defined in billions of dollars. The fact that utilities require billions in infrastructure limits the number of competitors. In most cases, we can talk about natural monopolies. It wouldn’t make much sense for three different electricity companies to spend billions on power generators and power lines to serve the same geographic area. Therefore, utility markets are typically well protected, and companies have nothing to fear, but themselves (e.g. poor management).

The combination of a stable business model along with the intention of distributing a good part of their profit in a form of dividends makes utilities perfect for retirees.

If you are looking to invest in renewable energy, you will see those companies in the utility sector. Renewable energy companies are getting much market love of late. Wind and Solar energy are getting cheaper to generate and governments offer generous subsidies for this type of power development. It’s not too late to jump in. It will be a long-term theme in the investment world.

Here are my favorite utilities to put in a retirement portfolio.

Xcel Energy (XEL)

Source: XEL June 2021 presentation

Source: XEL June 2021 presentation

The Company in a Nutshell

  • Utilities operate in regulated markets, which are typically more stable than unregulated markets.
  • XEL has successfully increased its dividend payment every year since 2003.
  • Management targets a payment increase of 5-7% for the coming year.

Business Model

Xcel Energy manages utilities serving 3.7 million electric customers and 2.1 million natural gas customers in eight states. Its utilities are Northern States Power, which serves customers in Minnesota, North Dakota, South Dakota, Wisconsin, and Michigan; Public Service Company of Colorado; and Southwestern Public Service Company, which serves customers in Texas and New Mexico. It is one of the largest renewable energy providers in the U.S. with one third of its electricity sales coming from renewable energy.

Investment Thesis

Utilities and stability could be used as synonyms. Xcel expects to invest $24B in new infrastructure between 2021 and 2025. This falls within its plan to become 100% carbon-free by 2050. Xcel has taken an early lead in renewable energy and it should pay off going forward. The utility enjoys a favorable geographic position as Minnesota and Colorado are among the best wind resources in the U.S. There is $18B from the $24B CAPEX that will be dedicated to these states. Xcel should also benefit from strong political and regulatory support for gas distribution system hardening projects. The chances of getting rate increase approvals for such projects is better than ever.

Potential Risks

XEL is going forward with a massive investment plan ($24B). Utilities usually expect regulators to approve rate increases commensurate with the money they invest. In a low-interest rate environment, debt is cheap, and regulators consider the lower cost of capital in their rate increase assessments. This could lead to less profitable projects going forward. Regulators may also consider the current recession before increasing rates to customers that already are hard pressed to meet their bills.

Dividend Growth Perspective

XEL Dividends

XEL Dividends

Xcel raised its dividend by 5.56% in February 2018 and kept going on the same trend in 2019 with an increase of 6.58%, and again with another 6.17% in 2020. This is what we call stable dividend growth. In their most recent presentation (Jan 2021), management plans to keep its 5-7% dividend growth target going forward. It also aims at a 60-70% payout ratio. Renewable energy is expected to contribute the highest growth for Xcel moving forward, but there are still many sources of stable income coming from their existing customers. Xcel should continue its streak of dividend increases for many years to come.

NextEra Energy Partners LP (NEP)

Source: NEE May 2021 investors presentation

Source: NEE May 2021 investors presentation

The Company in a Nutshell

  • NEE owns 65% of NEP and is IDRs (capped at 25%). That means most of its cash flow returns to NEE.
  • NEP owns 4.5 GW of wind projects and has recently invested in battery storage projects.
  • Since its IPO in 2014, NEP has increased its dividend by more than 225%.

Business Model

NextEra Energy Partners LP is formed to acquire, manage and own contracted clean energy projects. It owns interests in wind and solar projects in North America, as well as natural gas infrastructure assets in Texas. The renewable energy projects are fully contracted, use industry technology and are in regions that are favorable for generating energy from the wind and sun. Its natural gas pipelines in the portfolio are all strategically located, serving power producers and municipalities in South Texas, processing plants and producers in the Eagle Ford Shale, and commercial and industrial customers in the Houston area. Renewable energy sales generate maximum revenue for the company.

Investment Thesis

The first reason to buy NEP is you are getting a leader in renewable energy. Like it or not, companies like NEP (and NEE) will dominate the future energy markets. With renewable energy costs dropping quickly as technology evolves, it is likely that in a few years we will see those energy types becoming cheaper than classic coal/gas/nuclear energy sources. NextEra Energy continues to have several projects beyond 2021. If you are going for the yield, go for NEP (it’s a yieldco) and if you prefer the growth, go for NEE.

Potential Risks

NEP doesn’t have the most attractive credit rating with a BA1, BB and BB+ coming from Moody’s, S&P, and Fitch, respectively. Unusual financing structures such as BlackRock, convertible equity portfolio financing ($750M in exchange for an equity interest in the acquisition portfolio) may not always be that accommodating as the market is losing its appetite for new debt. Everybody is happy when interest rates are low, but this situation may eventually end. While NEP focuses on generating income (read higher yield), we prefer NEE.

Dividend Growth Perspective

NEP Dividends

NEP Dividends

If you look at NEP’s dividend growth trend, it looks like a straight line. This is because NEP is a YieldCo. Its purpose is to distribute as much money as possible to its parent’s company (NEE). At the same time, those distributions benefit to shareholders. Keep an eye on their distributable cash flow payout ratio from quarter to quarter to ensure you will continue to receive a bigger paycheck.

Con Edison (ED)

Source: Q1 2021 Investors presentation

Source: Q1 2021 Investors presentation

The Company in a Nutshell

  • Consolidated Edison is a classic utility with growth vectors in the natural gas distribution business.
  • ED shows over 40 consecutive years with a dividend increase making it a dividend aristocrat.
  • While the company and its dividends are solid, the stock is currently overvalued.

Business Model

Con Ed is a holding company for Consolidated Edison Company of New York, or CECONY, and Orange & Rockland, or O&R. These utilities provide steam, natural gas, and electricity to customers in southeastern New York--including New York City--and small parts of New Jersey. The two utilities generate roughly 90% of Con Ed's earnings. The other 10% of earnings comes from investments in renewable energy projects and gas and electric transmission. These investments have resulted in Con Ed becoming the second- largest owner of utility-scale PV solar capacity in the U.S.

Investment Thesis

Among all utilities, Con ED is likely the one that has been affected the most by COVID-19. New York City has been particularly hit by the virus which forced major lockdowns. Revenues are down and we don’t expect a full recovery for 2021. Having said that, we are interested in ED’s renewable energy production projects. ED is investing in its energy transmission and clean business in order to generate additional growth for the future. The company is now the 2nd largest owner of solar electricity production in North America, and is the 7th largest in the world. Overall, ED is offering a decent yield and its dividend growth policy covers inflation. That’s enough for many income-seeking investors. Since the company benefits from regulated business in New York, ED’s cash flow is stable and predictable.

Potential Risks

ED has a few important downsides. ED has increased its debt over the past 5 years. The long-term debt went from $14B to $23B (+64%) while revenue has remained stabled. The dividend payment is not at risk, but don’t expect massive increases. While interest rates have decreased in 2019 and have seemed to stay stable for 2020, this gives additional room for ED to grow without worrying about its debt repayment right away. As ED depends on New York’s regulators’ “generosity” to increase their rates, growth will be difficult in the coming years. Especially after New York Governor Andrew Cuomo announced that he formed a statewide Special Counsel for Ratepayer Protection.

Dividend Growth Perspective

ED Dividends

ED Dividends

Unfortunately for income investors, ED’s 5%+ yield is gone. After all, most utility stock prices jumped significantly in the past 5 years. In the meantime, its payout increased by 18%. Not CAGR, but 18% total from $0.65 in 2015 to $0.765 in 2020. You can expect another “inflation-based” dividend increases for 2020. In fact, ED needs a lot of cash for its capital projects and can’t afford to share additional cash with shareholders. A yield of around 4% is respectable, but don’t expect much growth. ED’s dividend will follow inflation for the next few years.

How To Get The Best Of The Utility Sector

Utilities have become quite popular following the 2008 financial crisis. As interest rates are kept at the bottom, income-seeking investors ignored bonds and certificates of deposit and looked to equities to provide good yields on their investments. Today, it’s hard to buy utilities at a discount. Especially if you are looking at renewable energy companies.

Since utilities can’t expand their business in another state or province without an acquisition, keep track of which regions have the best economic growth opportunities. At DSR, we prefer utilities using clean energy. They are more expensive, but they will continue to thrive during the next decade.

We also favor companies that have been around for a while. They have proven over a long time that they can reward shareholders even during challenging times.

Cheers,

Mike Heroux, Passionate Investor & founder of Dividend Stocks Rock

P.S. Are you concerned by the current state of the market? Download my free DSR Recession-Proof workbook and make sure you don’t suffer during the next market crash.

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**Please do your own due-diligence before investing in any stocks we discuss in this article**

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