The S&P 500 index currently offers a scant 1.3% dividend yield. The average utility is yielding about 2.9%, using the Utilities Select Sector SPDR Fund(NYSEMKT: XLU) as an industry proxy. That's more than twice what you'd get from the average S&P 500 stock, and highlights why utilities are a good place to shop when looking for dividend stocks.
Plenty of dividend stocks out there rely on borrowing as part of their business models and changes in interest rates have a direct effect on their operations. With the Federal Reserve lowering the fed funds rate last week (and strongly hinting that additional cuts are coming), the interest rates banks charge for borrowing are likely to drop over the next year or two. That should bode well for this class of stocks.
Here are three strong dividend-paying utility stocks set to benefit from the Fed's actions that investors will want to consider right away.
1. NextEra is a dividend growth story
NextEra Energy's (NYSE: NEE) dividend yield is 2.4%. That's actually below the utility average, which might discourage some investors. That's why a closer look is needed. The big story with NextEra is actually dividend growth. Not only has the company increased its dividend annually for three decades, but the average annualized increase over the past 10 years was a huge 10%! That includes increases over the past one-, three-, and five-year periods of 10%, suggesting this is a reliable dividend growth stock.
A 10% dividend growth rate would be good for any company. Half that rate would be pretty strong for a utility. The driving force behind NextEra's dividend growth is the mix of assets it has in its portfolio. The foundation is its regulated utility operation in Florida, a state that has long benefited from population growth. On top of that, NextEra has built one of the world's largest solar and wind companies. The clean energy investment has provided a historical growth opportunity, and it will continue to offer the runway for future growth as the world continues its shift toward cleaner energy alternatives.
Lower interest rates will make it easier to afford the capital spending needed to keep growing its clean energy footprint. If you are a dividend growth investor, you'll want to reexamine NextEra Energy now that the Fed's rate regime has shifted.
2. Dominion Energy is working on a turnaround
Dominion Energy(NYSE: D) hasn't been growing its business of late. It has been shrinking it. Its most recent move was to sell three natural gas utilities to Canada's Enbridge. The cash generated from that sale was put toward strengthening Dominion's balance sheet.
Utilities own assets that are expensive to build and maintain but that, thanks to regulatory oversight (and monopolies in the regions they serve), tend to produce reliable cash flows. As such, utilities generally make heavy use of leverage. But, sometimes, the debt load can get a bit ahead of a company. Fixing that situation is usually a slow process -- unless that is, a utility like Dominion starts raising cash in some other way. Selling assets is an example of a way to quickly reduce leverage.
With less leverage as a main management goal, however, Dominion is set to get an assist from the Federal Reserve's move to lower rates. In the grand scheme of things, 50 basis points isn't a massive change on an absolute level. But when you consider that the utility has $32.6 billion in debt on its balance sheet, every basis point counts! The benefit will show up first in revolving credit facilities, but over time the company's cost for refinancing debt will be lower, too.
Dominion's 4.6% dividend yield is well above average for a utility, but that's because it is a bit of a turnaround story. That said, it is a pretty low-risk stock, and the turnaround effort just got a little easier.
3. Black Hills is a Dividend King
With a market cap of $4.2 billion, Black Hills(NYSE: BKH) is a relatively small utility company. However, it has an above-average 4.2% dividend yield. That yield is extra attractive given that Black Hills has increased its dividend every single year for 54 consecutive years, making it a highly elite Dividend King. There are only a few other utilities that can make that claim, so if you care about dividend consistency, you'll want to have Black Hills on your shortlist.
Note, too, that the dividend has grown at a 5% annualized rate over the past decade. Sure, that's half the growth rate of NextEra Energy's dividend, but it's still a very solid number for a slow and steady dividend grower. The one wrinkle with Black Hills is that it tends to carry more leverage than other utilities, which means that rising interest rates tend to hit the company a bit harder -- thus the higher-than-average yield. But that story changes when rates are falling, as Black Hills will have an easier time on the interest expense front.
Unlike Dominion, Black Hills is not a turnaround story. It is just a well-run utility continuing to be well-run. However, if that sounds good to you, then you might want to buy it now. Falling interest rates will only make this (kind of boring) utility stock more compelling.
Lower rates are a good thing for utilities
NextEra Energy, Dominion Energy, and Black Hills aren't the only utilities that will benefit from falling interest rates. But they represent three different investment paths to consider, from dividend growth to a turnaround to a slow and steady dividend tortoise. The shift toward lower rates should make all of them more attractive investments.
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Reuben Gregg Brewer has positions in Black Hills, Dominion Energy, and Enbridge. The Motley Fool has positions in and recommends Enbridge and NextEra Energy. The Motley Fool recommends Dominion Energy. The Motley Fool has a disclosure policy.
