Southern Company (SO) is one of the top-yielding stocks in the utilities sector. It has rallied more than 35% so far this year, beating its peers. Going forward, the stock’s upside could be capped due to valuation concerns.
Southern Company’s solid run has lowered its dividend yield to 4.2%, but this is higher than its peers’ average of 3%. Although Southern Company’s yield looks superior compared to utilities at large, two utility stocks currently offer much higher yields. PPL Corporation (PPL) trades at a yield of 5.6% while the third biggest utility by market cap, Dominion Energy (D), yields 4.8%.
Alternatives to top utilities
Southern Company (including dividends) has returned around 40% this year. Investors continued to switch to relatively safer utility stocks this year amid uncertainties in the broader markets. PPL and Dominion significantly lagged their peers and returned 10% each this year. Although these stocks failed to pick up, they look attractive given their premium yields.
In 2019, PPL expects to pay a total dividend of $1.24 per share while Dominion Energy should pay a dividend of $2.75 per share.
PPL is a mid-sized regulated utility that operates primarily in the United Kingdom. It also has significant operations in Pennsylvania and Kentucky. PPL has been paying dividends for the last 294 consecutive quarters. This extensive dividend payment history suggests reliability and stability. The utility has increased its dividends 17 times in the last 18 years.
Dominion Energy also has a long dividend payment history. It has been paying dividends for the last 366 consecutive quarters.
Utilities generate relatively steady cash flows and typically offer stable dividend payments. Along with superior yields, dividend growth also plays a vital role when it comes to long-term total returns.
Dividend growth and payout ratios
Dominion Energy leads the above-mentioned peers in terms of dividend growth. It increased its dividends per share by more than 8% compounded annually in the last five years. Utilities at large grew dividends by around 4% in the same period. PPL and Southern Company’s dividends grew 2%–3% in the last five years, lagging their peers.
Because utilities typically pay a big portion of their income in the form of dividends to shareholders, they have higher payout ratios. US utilities have an average payout ratio of approximately 70%. In 2018, PPL’s payout ratio was 65% and Dominion Energy’s payout ratio was 88%.
Long-term total returns
However, we should note that these two top-yielding utilities significantly underperformed in the long term. PPL returned a mere 26% (including dividends) in the last five years while Dominion returned 38% in the last five years. The Utilities Select Sector SPDR ETF (XLU), the representative of the top utilities, returned 75% in the same period.
After a solid rally this year, Southern Company stock looks expensive compared to its historical trends. It is trading 19x its estimated earnings for the next 12 months. Its five-year historical average valuation is around 17x. For more information on the company, please read Will Southern Company Stock Continue to Soar?
In comparison, PPL and Dominion Energy stocks look notably cheap. PPL is trading 12x its estimated earnings compared to its historical average valuation around similar levels. Dominion trades 18x its forward earnings, and its five-year historical average valuation is around 24x.
Utility stocks at large seem to be trading at a large premium. They are trading close to 19x their forward earnings, which is significantly higher than the historical average.
PPL Corporation plans to invest $15 billion through 2023 in capital projects. The company’s management expects to increase its EPS 5%–6% annually, which might be enough to finance its dividends for the next few years. Its stable earnings growth indicates stable dividends going forward.
Dominion Energy is one of the fastest-growing utilities. Its EPS increased by an average of 6% in the last three years, surpassing its peers. We expect Dominion Energy to start reaping synergy benefits from its SCANA acquisition early this year. Higher contributions from Cove Point LNG terminal could boost its bottom line in the next few years.
For the next year, it aims to grow about 7%. After 2020, its EPS growth rate is expected to reach 5% per year. Even if Dominion Energy’s earnings growth rate is expected to slow down, it could still be superior to many of its top peers.
Analysts’ views and price targets of top utilities
Analysts gave Dominion Energy stock a mean price target of $81.30, which implies an estimated upside of just 3% for the next 12 months. It is currently trading at $78.40. Analysts seem cautious about the stock.
Among the 18 analysts tracking Dominion Energy, 12 recommended a “hold,” three recommended a “strong buy,” and three recommended a “buy.” None of these analysts recommended a “sell” on September 12.
Based on analysts’ estimates, PPL has a mean price target of $31.90 against its current market price of $30.80. This price target indicates a potential upside of 3.0% for the next year.
Of the 14 analysts covering PPL, nine recommended a “hold,” two analysts recommended a “strong buy,” and two recommended a “buy.” One analyst recommended a “sell” on PPL stock.
For a deeper look at the sector, please read Utilities Shine Bright amid Broader Market Weakness.