Undervalued by 17% and Yielding More Than 4%, This Dividend Stock Is a Buy

Duke Energy DUK is one of the cheapest utilities stocks that Morningstar’s analysts cover. We don’t think the market fully appreciates its growth potential in the constructive regulatory environments in which it operates. Not only does Duke land on our short list of The Best Utilities Stocks to Buy, it also appears on our list of The 10 Best Dividend Stocks. Morningstar chief US market strategist Dave Sekera includes Duke Energy among his stock picks in 3 Stocks to Sell and 3 Stocks to Buy in March, too.

Duke Energy is one of the largest regulated utilities in the United States. Florida is Duke’s most constructive and attractive jurisdiction, with higher-than-average load growth and best-in-class regulation that allows for higher-than-average returns on equity, forward-looking rates, and automatic base rate adjustments. In North Carolina, Duke’s largest service territory, the outlook has improved significantly. Legislation allows for multiyear rate plans, including rate increases for projected capital investments. Indiana remains constructive, allowing recovery for investments for renewable energy and future recovery on and of investments for coal ash remediation, with a forward-looking test year. Duke’s $73 billion capital investment plan for 2024-28 is focused on clean energy as the company works toward net zero carbon emissions by 2050 and net zero methane emissions by 2030. Management sees growth opportunities beyond its five-year forecast.

Key Morningstar Metrics for Duke Energy

• Fair Value Estimate: $112
• Star Rating: 4 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: Low

Economic Moat Rating

Duke’s regulatory environment is consistent with its peers and is supported by better-than-average economic fundamentals in its key regions. These factors contribute to the returns Duke has earned and have led to a constructive working relationship with regulators, the most critical component of a regulated utility’s moat. State and federal regulators typically grant regulated utilities exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their distribution networks. The risk of adverse regulatory decisions precludes regulated utilities from earning wide economic moat ratings. However, the threat of material value destruction is low, and normalized returns exceed costs of capital in most cases, leaving us comfortable assigning narrow moats to many regulated utilities.

Read more about Duke’s moat rating.

Fair Value Estimate for Duke Stock

Our fair value estimate is $112 per share. Our annual earnings growth forecast is at the top end of management’s 5%-7% guidance. Duke’s pipeline of growth opportunities, continued management of operating expenses, and constructive regulatory outcomes support our forecast. We don’t expect a material change in companywide average allowed returns. We expect Duke will continue to benefit from constructive regulatory rate increases to support its investment. In our discounted cash flow valuation, we use a 5.9% cost of capital based on a 7.5% cost of equity. This is lower than the 9% rate of return we expect investors will demand from a diversified equity portfolio, reflecting Duke’s lower sensitivity to the economic cycle and lower degree of operating leverage.

Read more about Duke’s fair value estimate.

Risk and Uncertainty

Regulatory risk is the key uncertainty, particularly given Duke’s significant investment planned for the next several years. Much of the company’s success hinges on the relationships it has built. Duke’s regulatory exposure is diversified due to operations in multiple constructive jurisdictions. Duke faces environmental, social, and governance risk, particularly given its relatively large coal fleet. Tightening environmental regulations could require significant capital investment or added operating costs. While we think natural gas will remain the primary source for heating in Duke’s service areas for the foreseeable future, there is risk that policymakers expedite the shift away from natural gas. An inflationary environment and rising interest rates would raise borrowing costs and make other investments more attractive than regulated utilities for income-seeking investors.

Read more about Duke’s risk and uncertainty.

Duke Bulls Say

• Duke’s regulated utilities provide a stable source of earnings. The company’s large capital expenditure plan should drive rate base and earnings growth for the next several years.
• The company operates in constructive regulatory jurisdictions, supporting capital investment growth.
• Duke’s management team has focused on core regulated operations and moaty growth investments.

Duke Bears Say

• Equity issuances and capital investment delays have hurt management’s relationships with key stakeholders.
• Duke’s aggressive investment plan increases regulatory risk.
• As with all regulated utilities, rising interest rates will raise financing costs and could make the dividend less attractive for income investors.

This article was compiled by Susan Dziubinski and Sylvia Hauser.