Duke Energy: Where Is The Power? (NYSE:DUK)

Shares of Duke Energy (NYSE:DUK) are doing exactly what can be expected from a utility provider that is paying out a compelling dividend yield while being a long-term steward of capital.

To see where the company is coming from, I go back to 2015 when the company acquired Piedmont to grow its natural gas operations in the Carolinas, at quite a steep premium. That premium and a mixed acquisition track record raised some questions. This came as any appeal had to come from a solid dividend yield and low interest rate environment, as I was a bit uncertain with the $4.9 billion deal adding quite some leverage as well.

Back To 2015

The $4.9 billion deal to acquire Piedmont, or $6.7 billion after accounting for assumed net debt, was set to add a million customers in the Carolina’s and Tennessee. Besides increased scale, there have been other strategic rationales for the deal as well, as both companies have been working on the Atlantic Coast Pipeline project at the time.

Duke at the time was earning between $4.55 and $4.75 per share, as a 65-70% payout ratio translated into a solid dividend which has been paid out for 89 years in a row at the time, or nearly a hundred years by now. The issue, which is an issue for all utility providers, is that net capital investments are huge with networks needed to transform and be upgraded as well.

The company guided for $23-$26 billion in capital spending in the period 2015-2019, a huge amount as the company operated with a pro forma net debt load of $46 billion at the time, for a 4.7 times leverage ratio based on $9.7 billion in EBITDA.

Shares of the company traded around the $70 mark in 2015 as a 4.6% dividend yield looked compelling, yet free cash flow power was very limited to grow, or transform the operations and reduce debt.

What Happened?

Since 2015, shares of Duke have steadily moved higher with relatively little volatility, as shares have moved traded $85 and $115 over the past year, now trading at $100 per share.

Fast forwarding between 2015 and 2021, Duke has seen limited earnings growth. In February of this year, the company posted adjusted earnings of $5.24 per share for the year 2021, up twelve pennies from the year before. Between 2015 and today, revenues has been flat at $25 billion, with roughly 90% of sales generated from regulated electric operations and the remainder coming from regulated gas operations.

The company posted EBIT of $5.4 billion on which net earnings of $3.8 billion were reported, for GAAP earnings of $4.94 per share as the company keeps incurring dilution. Based on $5.0 billion in depreciation charges, EBITDA was reported at $10.4 billion all while net debt inched up to $66 billion. This comes as net capital spending remains elevated with a five-year capital spending plan now pegged at $63 billion, or about $13 billion on average, surpassing depreciation charges by $8 billion per year! This makes that net debt is only on the increase, and investors likely see dilution as well.

Interest expenses remained in check in 2021, but they will increase going forward amidst rising interest rates as the dividend runs at $4.02 per share here, pushing up payout ratios further towards the 100% mark.

Looking Forward

For the year 2023, the company already guided for continued earnings growth, seeing earnings between $5.55 and $5.75 per share. Through 2022 the company has seen solid revenue growth with revenues up $3 billion in the first three quarters of the year on the back of higher prices resulting in modest earnings growth and no further dilution incurred by investors.

Net debt kept increasing to about $70 billion here amidst continued net capital investments as a high dividend yield did not allow for much deleveraging, or any deleveraging at all. For now, interest expenses remain in check, with massive capital spending needed to reform the power generation mix of the business.

To combat the continued rise in leverage, the company has announced that it is exploring strategic alternatives for its commercial renewables business, with the activities to be classified as discontinued operations by the fourth quarter already.

This could be accretive to leverage (read reduce leverage) as these are capital intensive operations. That being said, a deal is likely in the billions, making a dent to manage leverage, but not going a long way in addressing the high debt load. This remains the tricky part, albeit that its status as regulated utility provides comfort. But with the ongoing transformation of the gird, the question is if this status is as protective in the future as it has been in the past.

Concluding Remark

The truth is that shares are trading flat so far this year, trading around the $100 mark, after a big recovery in recent weeks and months on top of interest rates flattening out here. The reality is that the dividend is at par with interest rates, while offering very modest growth while leverage is high, which makes that I am surprised by the resilience of the shares in this interest rate environment, given that other utilities have sold off as well.

This outperformance could be explained by Duke’s movement to transform its power generation mix to more renewable sources, yet in that light it is a bit puzzling why some part of the renewable are being sold off now, although it is likely needed to control debt. Given all of this, I am puzzled behind the current valuation, as shares offer no decent risk-reward here in my opinion.