Medium-Cap Utility Stocks with a Dividend Growth Potential

Published Tue, 11 Aug 2015 14:30 CET by

Evidence shows that low beta stocks with realistic P/E ratios can diversify a stock portfolio and generate growth dividends. Medium cap stocks may be less trendy than large cap stocks, but often they outperform their growth-oriented peers. This happens because growth is not fail-safe in a volatile market.

There are three factors that one should look at when selecting a dividend paying stock. The first factor is the payout ratio, which suggests how well a company’s earnings can support its dividend payments. The lower the payout ratio, the more guaranteed the dividend. However, payout ratio should be evaluated in relation to EPS. The second factor is the 52-week high and low range. There is an inverse relationship between the stock price and the dividend yield. If an investor buys a stock at a price close to its 52-week low, the dividend yield is likely to be closer to the stock’s 52-week high % and vice versa. Because the 52-week high and low range is dynamic, it is recommended to look at the payout ratio as well to see if there is room for value appreciation for a dividend paying company. The third factor is beta. For risk-averse investors who are concerned with market volatility, beta is a good indication about dividend growth. Most low beta stocks sustain volatile markets.

The table below compares two medium-cap stocks with a relatively large-cap stock in the Gas Utilities industry. All factors considered, all three stocks could be considered for constructing a growth portfolio. Here is the summary of the three featured dividend-paying stocks.

Name Price ($) 52 wk low 52 wk high 52 wk low % 52 wk high % Market Cap ($ b) P/E Beta D/E
FirstEnergy 34.26 32.10 41.68 6.73% -17.80% 14.46 46.05 0.11 181.99
AGL Resources 48.70 46.36 57.65 5.05% -15.67% 5.84 14.87 0.28 104.06
WGL Holdings 55.29 40.99 59.08 34.89% -6.42% 2.75 16.41 0.89 87.88

FirstEnergy (NYSE: FE) engages in the generation, transmission and distribution of electricity across the U.S. and through its three major segments, it caters to nearly 13.5 million customers by providing energy-related products. It is a large cap stock with the highest P/E ratio and the highest dividend yield, but it clearly faces debt management issues, which are reflected in its payout ratio. Current EPS is $0.74, but analysts estimate that EPS 2015 will be $2.70, generating a dividend close to $1.62 and lowering the payout ratio to about 60%. First Energy’s decision to turn to the regulated market is paying off. The company is expected to stabilize its business, in spite of the growing concerns over air pollution and competition coming from cheaper gas fired plants. The pressure on revenues, earnings and the stock price will be evident, but First Energy’s focus on improving its delivery systems will improve its EPS, going forward. Currently, the company trades slightly above its 52-week low and way low its 52-week high. According to analyst consensus, the mean target price is 36.60 for 2015.

AGL Resources (NYSE: GAS) is a medium cap stock with a high EPS $3.28 and a low payout ratio, but a relatively high D/E ratio. If used wisely, debt can leverage EPS so that AGL doesn’t have to spend cash on interest expenses. With a beta of 0.28 the stock is not volatile. Furthermore. AGL’s strategic decision to capitalize on its brand and deliver a renewable energy portfolio and the largest, cost-effective thermal electricity project to more than 3.7 million customers, suggests that the company will further strengthen its positioning in the sector, thus increasing profitability and dividend growth.

FE, GAS and WGL Price Performance Year over Year Graph
WGL Holdings (NYSE: WGL), through its leading subsidiary Washington Gas, has provided natural gas service to customers in the D.C. area for over 160 years and serves more than one million customers in the District of Columbia, Maryland and Virginia. WGL has the highest EPS ($3.37) and the lowest payout ratio with realistic P/E and beta. However, the company is progressively becoming more dependent on debt. Following a total issue of $250 million of long-term debt between October and December 2014 in 5-year and 30-year notes, WGL’s long-term debt reached 950 million in Q1 2015, an increase of about 40% from Q3 2014 (679 million). WGL Holdings’ focus on retail energy is expected to be a key factor for the company’s earnings potential. Consensus estimates an EPS between $2.70 and $2.90, which may be lower than the current EPS, but still leaves room for high dividend. Currently, WGL is way above its 52-week low and slightly lower than its 52-week high, suggesting that, in spite of its temporary debt management issues, it is definitely a small-cap stock to consider for dividend growth.

Stock name Dividend Yield
Firstenergy 3.25
Wgl Holdings 2.44

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