Utilities (XLU) generally pay a large portion of their earnings in the form of dividends to their shareholders, which is called the “payout ratio.” Recently, US utilities’ payout ratio averaged ~65%–75%. Duke Energy’s (DUK) payout ratio was 97%, while Southern Company’s (SO) ratio was 110% in 2018. Southern Company’s higher payout ratio shows that the company paid more in dividends than its earnings last year.
Squeezing free cash flows
Regulated utilities usually have higher payout ratios than competitive utilities. Southern Company’s five-year average payout ratio is ~111%, while Duke Energy’s ratio is 89%.
Many utilities witnessed negative free cash flows due to their increased capital expenditure needs and declining operation cash flows in the last few years. Southern Company and Duke Energy recorded negative free cash flows in the last three years. Companies generally use free cash flows for dividend payments and expansion projects.
American Electric Power’s (AEP) payout ratio was 65% in 2018. NextEra Energy’s (NEE) payout ratio was ~34%—lower than its five-year average of 46%. NextEra Energy’s notably lower payout ratio indicates the potential for higher dividends in the future.