Income investors rely on utility stocks for steady dividends. Utilities have earned a strong reputation among income investors, and for good reason.

Utilities are widely recognized for their ability to generate steady profits each year, regardless of the economic climate. With their reliable earnings, they consistently pay dividends each year.

Many utility stocks have paid uninterrupted dividends for several decades on end, with annual dividend increases along the way.

There are many utility stocks on the list of Dividend Achievers, which have raised their dividends for 10+ consecutive years. 

The other attractive aspect of utility stocks is that their high dividend yields.

Utilities can keep paying dividends so consistently, because their business models are heavily regulated, and are a necessity to modern society. And, utility stocks extremely resistant to recessions. Everyone needs to keep the lights on, even when the economy enters a downturn.

Add it all up, and it is abundantly clear why income investors favor utility stocks.

This article will discuss the 5 top utility stocks today—in no particular order—based on their fundamentals, valuations, and dividends.

Utility Stock #5: Brookfield Renewable Partners (BEP)

Dividend Yield: 6.2%

Price-to-Earnings Ratio: 23.4

Leading off is Brookfield Renewable Partners. It operates in the utility sector, but it is much different than most other utilities.

While most utilities derive electricity from coal and natural gas, Brookfield has a portfolio of renewable energy assets. Nearly 90% of its generation comes from hydroelectric power, with the remainder from wind energy.

Source: Q1 Earnings Presentation, page 6

Approximately two-thirds of the company’s generation is based in the U.S., but it also has a significant international presence:

• North America (65% of generation)
• Brazil (15% of generation)
• Colombia (15% of generation)
• Europe (5% of generation)

Brookfield is a unique stock. Not just because of its business model, but also because of its unusually high dividend yield.

While most utility stocks yield 3%-5% right now, Brookfield has a yield exceeding 6%.

It is one of 405 stocks with a 5%+ dividend yield. 

Another differentiator for Brookfield, is that it operates as a Master Limited Partnership, or MLP.

MLPs are a unique asset class with a tax advantaged structure, which helps them pay such high dividend yields. 

Brookfield is seeing growth rates above that of most traditional utilities, thanks to the renewable energy boom. Revenue increased by more than 50% last year.

Brookfield’s adjusted FFO (Funds From Operation, a non-GAAP financial measure similar to earnings-per-share) increased 8% in 2016, to $1.83.

Brookfield uses FFO to determine its dividend rate. It declared distributions of $1.78 per share in 2016, which means the dividend was sufficiently covered.

For the first quarter of 2017, Brookfield’s generation increased 4.5% from the same quarter last year. Adjusted FFO-per-unit increased 10% year over year.

Going forward, Brookfield has a promising growth outlook, thanks to rising demand for renewable energy.

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Source: 2016 Investor Meeting Presentation, page 7

Brookfield intends to pursue growth in these areas, through organic investment, as well as with acquisitions.

For example, in its Brazil operations, Brookfield commissioned a 25-megawatt hydro facility last quarter, which is expected to add $20 million in annual FFO moving forward.

It has additional projects set for 2019 and 2020, which are expected to add another $25 million-$30 million in annual FFO.

The company has also made significant acquisitions over the past several years, including the purchase of a 51% interest in TerraForm Power (TERP), which added approximately 3,600 megawatts of capacity to Brookfield’s portfolio.

Continued growth will allow Brookfield to continue raising its dividend. Management maintains a forecast of 5%-9% distribution growth per year, moving forward.

Brookfield has a modest capital structure, which helps support the dividend payout. The company has a manageable debt-to-capitalization ratio of 38%. It has an average debt maturity of 7.1 years, at a reasonable interest rate of 4.5%.

Assuming its growth projects are completed on schedule, the company should be able to pay its debts, and have enough cash flow left over to raise the dividend as planned.

Brookfield stock carries a slightly above-average valuation compared with the broader utility sector. However, the company justifies its premium valuation, with its growth potential and high dividend yield.

If Brookfield’s growth remains on track, the stock could be very appealing for income investors, because of its rare combination of high yield and high dividend growth.

Utility Stock #4: American Electric Power (AEP)

Dividend Yield: 3.5%

Price-to-Earnings Ratio: 17

American Electric Power is another giant in the utility sector. It is one of the largest electric utilities in the U.S., with over 5 million customers across 11 states.

Its assets consist of more than 40,000 miles of electricity transmission, the largest such network in the country. It also possesses approximately 26,000 megawatts of generating capacity.

American Electric operates almost exclusively in regulated operations. Approximately 97% of annual earnings come from regulated businesses.

This strategy has served the company well. Operating on the regulated side allows utilities virtually guaranteed growth. Regulated utilities are permitted to raise rates each year.

From 2016-2019, American Electric expects to generate 7.7% compound annual growth of its rate base.

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Source: June 2017 Investor Presentation, page 7

Through the trailing 12-month period ending March 31st, American Electric’s regulated businesses generated a combined return on equity of 10.4%.

Management expects a 10% return on equity from 2017-2019.

In 2016, American Electric’s revenue declined fractionally, to $16.4 billion. However, adjusted earnings-per-share increased 6.8% for the year, thanks to cost controls.

On an adjusted basis, earnings-per-share were $3.94 in 2016.

2017 got off to a bumpy start for American Electric. Revenue dipped slightly in the first quarter, to $3.9 billion. However, operating earnings-per-share fell 5.9% year over year, to $0.96.

Like other U.S. utilities, American Electric dealt with unseasonably warm weather to start the year. That said, the long-term growth outlook remains intact.

Through 2019, American Electric expects to grow adjusted earnings-per-share by 5%-7% per year.

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Source: June 2017 Investor Presentation, page 5

This forecast is actually an acceleration from the prior guidance, which called for 4%-6% annual earnings growth.

American Electric raised its earnings guidance, in large part because of higher investments in its core operations, and in renewable energy.

On November 1st, 2016, the company announced plans to invest approximately $17.3 billion from 2017-2019 to modernize its assets and increase renewable capacity.

American Electric has a relatively low dividend yield for a utility stock, at 3.5%. However, it is a high-quality business, and makes up for its low yield with solid dividend growth.

It has paid out uninterrupted dividends for more than 400 consecutive quarters, a streak of over 100 years.

Last year, the company raised its dividend by 5.4%. From 2013-2017, the company increased its dividend by 5% per year. This is a higher dividend growth rate than many of its utility peers, which typically raise dividends in the 2%-4% range.

American Electric has manageable debt levels. Maturities total roughly $1.4 billion-$1.5 billion in 2018 and 2019, before rising to $2 billion in 2019.

However, debt maturities decline substantially in 2020, to $194 million. Maturities will then total just $1.3 billion and $817 million in 2021 and 2022, respectively. The company maintains a healthy target debt-to-capitalization ratio between 55%-60%.

American Electric receives a BBB+ credit rating from Standard & Poor’s, which is solidly investment-grade.

American Electric’s growth outlook and comfortable financial position should allow it to continue increasing its dividend by 4%-6% each year.

Along with earnings growth, the company expects total shareholder returns of 9%-11% annualized moving forward, which should be an appealing level of returns for income investors.

Utility Stock #3: Duke Energy (DUK)

Dividend Yield: 4.3%

Price-to-Earnings Ratio: 18

Duke Energy is an electric and gas utility. Its major regulated business serves more than 7 million electric customers, in six U.S. states. It also distributes natural gas to more than 1.5 million U.S. customers.

Duke Energy’s grid is the largest in the U.S., stretching more than 300,000 miles.

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Source: Spring 2017 Retail Investor Conference, page 4

Duke Energy’s adjusted earnings-per-share increased 3.3% in 2016, to $4.69. Growth was due to acquisitions, and cost controls.

In 2012, Duke Energy and Progress Energy came together in a $32 billion merger.

In 2015, it acquired Piedmont Natural Gas for $4.9 billion, which tripled Duke’s natural gas customers. Duke Energy had another 1.2% growth in gas customers last quarter.

Over the next 10 years, Duke Energy expects natural gas to represent 15% of its business, up from 8% today.

The Piedmont deal has proven to be significantly accretive to earnings.

Integration costs are declined significantly in the first quarter, to $10 million, down from $74 million in the same quarter last year.

Piedmont contributed $101 million to earnings, a boost of roughly $0.14 per share last quarter.

Duke has also restructured its portfolio, after divesting its international business.

Duke got off to a weak start to 2017. Adjusted earnings-per-share declined 8% in the first quarter, due to unseasonably warm weather across the company’s operating regions.

However, this was partially offset by lower storm restoration costs, compared with the same quarter last year.

Duke has a positive growth outlook. Going forward, nearly 100% of earnings will come from U.S. regulated activities, which tend to be more stable.

In the 10-year period through 2016, Duke Energy invested $25 billion to modernize its regulated utility assets.

Another growth catalyst for Duke Energy moving forward is renewable energy. Renewables make up just 3% of the company’s 2017 projected earnings, but are poised to grow rapidly from here.

Duke Energy management expects to invest $1 billion in renewable energy through 2021, which is projected to result in 8%-12% growth in the renewables business.

Duke Energy has paid dividends for more than 90 years, and it is a member of the Dividend Achievers.

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Source: Spring 2017 Retail Investor Conference, page 11

Its dividend payout appears to be sustainable.

Duke Energy maintained a dividend payout ratio of 73% based on 2016 earnings.

Duke expects to increase its dividend by roughly 4% per year moving forward. Duke’s last dividend raise came on July 17th, when it hiked its dividend by 4.1%.

The company expects to maintain a payout ratio of 70%-75% through 2021. This should give it enough breathing room to deliver mid-single digit dividend growth each year.

Duke Energy also has a solid credit rating of A- from Standard & Poor’s.

Over the long term, Duke Energy expects to grow earnings-per-share by 4%-6% per year. This should be enough to meet the dividend growth forecast.

On a valuation basis, Duke has a modest price-to-earnings ratio. It may not see its valuation multiple rise much from here, but it should also not see a significant contraction in the valuation multiple.

Combined with its 4.3% dividend yield, it is reasonable to forecast 8%-10% annualized returns for Duke Energy going forward.

Utility Stock #2: Southern Company (SO)

Dividend Yield: 4.9%

Price-to-Earnings Ratio: 18

Southern is an electric utility, which serves approximately 9 million electric and gas customers, primarily in the southeast U.S.

Southern is an attractive dividend stock because it offers one of the higher yields in the electric utility industry.

Southern has a long track record of steady dividends, and regular dividend growth.

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Source: Q1 Earnings Presentation, page 11

Since 1948, it has either paid a flat or increased dividend. It has also raised its dividend for 16 years in a row, which makes it a Dividend Achiever.

Its dividend has historically been a major driver of Southern’s total returns. According to the company’s 2016 annual report, reinvested dividends have represented approximately 69% of Southern’s returns.

A $1,000 investment in Southern stock in 1996 would be worth roughly $9,400 by the end of 2016. The same investment in the S&P 500 Index would be worth just $4,400.

Part of Southern’s returns are attributable to the company’s ability to adapt to new circumstances. An example of this, is tSouthern has shifted its energy mix in recent years.

Nearly half of its generation now comes from natural gas. Coal represents almost one-third of its generation, with the remainder from nuclear energy and renewables.

Natural gas is a strategic priority for Southern. In 2015, it acquired AGL Resources in a $12 billion deal. The acquisition not only expanded Southern’s natural gas capacity, but it also broadened Southern’s geographic footprint, by giving it a presence in several Midwest states.

2016 was a challenging year for Southern’s bottom line. Revenue increased 14% for the year, but full year earnings-per-share came to $2.57 per share, down 1% from the previous year.

One of the difficulties facing Southern is the ongoing problem at its major Kemper project. Southern has poured billions into the Kemper facility, which was once promised to be a landmark advancement in clean coal technology.

However, repeated cost overruns have weighed on Southern for several years. The company has taken more than $1.5 billion in charges against earnings since 2013, due to Kemper, including a $428 million estimated loss last year.

Fortunately, conditions improved in the first quarter of 2017. Earnings-per-share increased 25%, to $0.66.

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Source: Q1 Earnings Presentation, page 8

Earnings growth was due to stronger performance at Southern Company Gas, which was acquired in 2016.

In addition, earnings growth was helped by lower operating and maintenance costs.

Southern is a good example of a highly stable utility. It is very resistant to recessions, as it proved during the 2008-2009 Great Recession.

Earnings held up extremely well, while the broader economy was deep in recession:

• 2007 earnings-per-share of $2.28
• 2008 earnings-per-share of $2.25
• 2009 earnings-per-share of $2.32
• 2010 earnings-per-share of $2.36

As you can see, the company experienced only a modest decline in 2008, and returned to growth in 2009 and 2010.

With a nearly 5% dividend yield and a reasonable valuation, Southern investors stand a good chance at earning high single-digit total returns moving forward.

The dividend is highly sustainable. 2016 earnings-per-share of $2.57 easily cover the current annualized dividend payout of $2.32 per share.

Southern’s 90% payout ratio is on the high side, but the company expects to continue generating low-to-mid single digit earnings growth over the long-term.

This should provide enough room to sustain the current payout, and increase the dividend each year.

Utility Stock #1: Consolidated Edison (ED)

Dividend Yield: 3.4%

Price-to-Earnings Ratio: 18

Last but not least, ConEd has earned a place on the list, because it is the only utility stock on the Dividend Aristocrats list.

The Dividend Aristocrats are members of the S&P 500 Index, with 25+ consecutive years of dividend growth. 

ConEd has increased its dividend each year, for more than 40 years.

It has maintained such an impressive dividend growth history, because it is a perfect example of a slow-and-steady utility.

ConEd provides electric service to approximately 3.3 million customers, and gas service to approximately 1.1 million customers, in New York City and Westchester County.

Its Orange & Rockland subsidiary provides electric service to more than 300,000 customers in New York, New Jersey, and Pennsylvania, and gas service to 130,000 customers in New York.

Electric operations make up the vast majority of ConEd’s business:

• Electric (71% of revenue)
• Gas (14% of revenue)
• Steam (5% of revenue)
• Non-Utility (10% of revenue)

In all, ConEd generates $12 billion of revenue each year, and has $48 billion of assets.

ConEd’s earnings-per-share increased 2% in 2016, to $4.15. Adjusted earnings-per-share, which excludes non-recurring items, rose 13% in the fourth quarter.

Earlier this year, ConEd received approval for its three-year rate base plans, in its electric and gas delivery businesses.

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Source: First-Quarter 2017 Presentation, page 16

Rate increases are an important growth driver for ConEd, which relies heavily on its regulated businesses. From 2017-2019, the company expects to generate 5.5% compound annual growth in its average rate base.

ConEd’s performance has improved to start 2017. In the first quarter, ConEd reported 7.6% growth in adjusted earnings-per-share.

Earnings were boosted by the core electric utility business. ConEd enjoyed higher gas net base revenue, higher electric net base revenue, and an increase in total gas customers.

ConEd also benefited from lower pension expense last quarter. The company has seen operating expenses increase in recent years, as it invests additional resources to modernize its assets.

However, it has mitigated the damage from this, thanks to cost discipline elsewhere.

(Click on image to enlarge)

Source: First-Quarter 2017 Presentation, page 14

ConEd also got a boost from its renewable energy segment last quarter, which contributed $0.15 to earnings-per-share for the period.

The first quarter was a strong performance on both the top and bottom lines. ConEd beat analyst expectations for earnings-per-share by $0.08. Revenue increased 2% for the quarter, and also beat analyst estimates, by $20 million.

For 2017, ConEd expects adjusted earnings-per-share of $3.95-$4.15. At the midpoint of guidance, adjusted earnings-per-share are expected to rise by approximately 2% for the full year.

ConEd is not a high-yield dividend stock, but its dividend payout is highly secure. It has a strong balance sheet, with a BBB+ credit rating and stable outlook from Standard & Poor’s.

And, ConEd has a comfortable payout ratio.

ConEd aims for a target payout ratio of 60%-70% of annual adjusted earnings-per-share. It is right within that range, which means it is highly likely the company will remain a Dividend Aristocrat for the foreseeable future.

Investors may be used to higher dividend yields from utility stocks, but ConEd makes up for this with dependable payouts and dividend growth each year.

Utility stocks are often viewed similarly to bonds, but there are two key factors working in utilities’ favor. First, utility stocks like ConEd raise their dividends each year, while bonds do not offer inflation protection.

Second, bond yields are fairly low, particularly among the safest issues. The yield on the 10-year U.S. Treasury Bond is just 2.27%, which is not attractive for income investors.

As a result, for investors willing to accept the higher level of risk associated with investing in individual stocks, utility dividend yields are appealing.

Final Thoughts

Utility stocks have performed well over the past several years, delivering share price appreciation and hefty dividends to investors.

Right now, it is hard to make the case that utility stocks are significantly undervalued, given their modest growth potential, and the prospect of higher interest rates going forward.

That said, they do not appear to be overvalued either, as most utility stocks have price-to-earnings ratios under 20.

As a result, investors should keep their expectations modest for utility stocks. A reasonable forecast for this group of five stocks, is total annualized returns in the high single-digits moving forward.

But, this might be just what risk-averse income investors, such as retirees, are looking for. Utilities are much less volatile than most other stocks.

There is arguably no other sector that can offer the same combination of high dividend yields, dividend growth, and ability to withstand recessions.

From that perspective, the utility stocks on this list are attractive for investors looking for stable dividend payers.