Utilitarian Dividends

By Stephen D. Simpson, CFA | May 16, 2011 AAA

It is hardly controversial or innovative to look for quality dividend-paying stocks in the utility space. These companies typically operate as monopolies in their respective regions, and regulators are generally quite willing to grant rates to utility operators that all but ensure solid dividend payouts. That does not mean, though, that the entire industry is uniform and undifferentiated. As with any sector, investors do well to pick and choose among the best options available for their portfolio needs. (For more, see Trust In Utilities.)

Tutorial: The Industry Handbook

Consolidated Edison (NYSE:ED)
Con Ed is a staple on lists of quality dividend-paying utility companies. Con Ed is the utility that provides electricity, gas and steam to New York City, and the company has a long dividend-paying history and a very secure corporate structure. Today's 4.5% yield is above the industry average, as is its payout ratio. Dividend growth and return on assets (ROA) have been below average, but Con Ed is a strong choice as a cornerstone utility holding.

CH Energy Group
(NYSE:CHG)
CH Energy, the holding company of Central Hudson Gas & Electric, is the electricity and gas distributor for much of upstate New York, as well as operating cogeneration and ethanol operations in other states. Paying a 4.1% dividend yield today, the company could be in position to raise the payout in a year or two. Like Con Ed, CH Energy's payout is above average and the ROA is below average, but the financial stability looks good. (For more, see Dividend Facts You May Not Know.)

Exelon
(NYSE:EXC)
As the largest nuclear plant operator in the U.S., Exelon gets an above-average amount of press, and particularly when new concerns or threats emerge regarding nuclear power. Still, for however much some people don't like nuclear power, it is quite unlikely that Exelon will be forced to shut down those plants. In the meantime, the plants provide the company with a great deal of very cost-competitive electricity. The proposed merger with Constellation Energy (NYSE:CEG) puts integration risk back on the table, but Exelon offers an above-average dividend yield and good leverage to higher coal prices.

NSTAR
(NYSE:NST)
NSTAR distributes electricity throughout Massachusetts and is looking to close its merger with Northeast Utilities (NYSE:NU). NU is the acquiring company and looks to combine its distribution assets in New Hampshire, Connecticut and Massachusetts with NSTAR's for greater efficiency and scale. Both are fine companies, but investors would likely be better off with NSTAR in the event that the proposed merger does not go through.

Southern Company
(NYSE:SO)
Southern is something of an outperformer - offering a better yield, better ROA, better historical dividend growth and better financial stability than most of its comparables. Not only is Southern Company's 4.7% yield attractive, but the company operates in a region of the country seeing net population growth. Plus, the company has traditionally had very good relationships with its regulatory bodies. Recent storms in the Southeast are a setback, but a recurring cost of business.

Two Off-The-Grid Operations

E.ON
(OTCBB:EONGY.PK)
E.ON is one of the largest utility operators in the world and produces about one-third of Germany's electricity. E.ON offers a very attractive dividend yield (7.1%) and a management team that has shown itself to be focused on cost-efficient growth. The company's large reliance on Russian gas is a threat, as is the substantial base of nuclear power generation (Germany's environmentalists make America's look like weekend warriors). Nevertheless, E.ON is a good option for international diversification in a dividend-oriented portfolio.

Covanta
(NYSE:CVA)
Covanta does not pay much of a dividend today, at least not by utilities' standards, but this could be worth a look as a "dividends and growth" play as well as a "dividend growth" play. The company's waste-to-energy model is currently seeing pressure from flat electricity prices and rising fuel costs, but the company recently initiated a dividend and has been judicious in selling non-core assets. Waste-to-energy is surprisingly environmentally friendly (on a relative basis) and could have a brighter future as landfill space becomes more expensive.

The Bottom Line
Dividend investing is certainly not a risk-free way to generate income, so investors should always be sure to diversify their portfolios. That said, utilities have a well-earned reputation for sustained dividend payouts, and investors could certainly do worse than to consider some of the names on this list. (For more, see Dividends Not To Be Ignored.)

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