3 Utility Stocks to Replace Bonds for Income Seekers

A US interest rate hike is off the table; we reveal three US income stocks with sustainable yields that generate a better return than government bond yields 

Karen Kwok 9 May, 2016 | 4:30PM
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The April US jobs report unveiled on last Friday was uninspiring – disappointing economists’ expectations. Signs of weakness led to speculation that the US Federal Reserve will choose to delay its next interest rate rise in June.

Non-farm payroll employment rose by 160,000 jobs in April compared to economist estimates for a jump of about 200,000 jobs, according to the Labor Department.

Economist at Royal London Asset Management, Ian Kernohan, said that the employment number was not a disaster but it was not strong enough to boost policy makers’ confidence for additional rate rise. The next few US employment reports will take on critical importance.

“There is a lot of data to come between now and the June Fed meeting, however, given that the Fed place most weight on labour market trends, these numbers are not quite strong enough on their own to firm up a rate hike next month,” Kernohan said.

Utilities Stocks Take the Place of Weak Bonds

With rate hike expectations on hold, government bond yields have also been very weak and it is hard for investors to generate good returns out of a low interest rate environment. Instead, investors have been looking to equities and US income stocks can be a source of income to investors, especially in the utilities sector, according to Morningstar analyst Charles Fishman.

“Utilities' dividend yields have rarely been so attractive relative to interest rates. And we think utilities' dividends, credit metrics, and growth prospects are as strong as they have been in decades. The spread between utilities' 3.7% yield and the 1.7% 10-year U.S. Treasury yield is as wide as it has been since May 2013, a historically bullish signal for utilities and bearish signal for bonds,” said Fishman.

As below, we pick three US income stocks with attractive yields. Two of them are utilities stock while the third stock is a communication company. We have left out stocks with extremely high yields because a high yield can often be a result of depressed share prices – which may mean the dividend itself is at risk.

3 Income Stocks for Yield Seekers

CenterPoint Energy (CNP) owns a portfolio of energy-related businesses. Its regulated electric utility provides transmission and distribution services to Houston and the surrounding area. The company has natural gas distribution systems in six states. It is rated as a three-star fair valued stock by Morningstar analyst with a 4.62% yield.

CenterPoint's regulated utilities have significant investment opportunities even though sustained low natural gas and oil prices have lowered Morningstar analysts’ expectations for earnings and cash distributions from Enable Midstream Partners LP. However, utility earnings growth and cash distributions from Enable remain strong and they should allow annual dividend growth exceeding 4% during the next five years, according to Fishman. He expected the increase as management had previously indicated it would recalibrate the dividend after the formation of Enable. 

The formation of Enable will allow CenterPoint to focus capital expenditures on its utilities, resulting in an estimated 5.5% annual rate-base growth during the next five years, according to Fishman.

Another utilities company Dominion Resources (D) also delivers attractive yielding at 3.71%. Morningstar analysts think investors should watch this company as it has strong economic moats, trading at a discount to peers and it has a yield near 4%. The stock is also rated as a fair-valued stock.

Dominion operates one of the nation's largest natural gas storage systems with 928 billion cubic feet of capacity. The company is constructing an LNG export facility in Maryland and is 45% owner of the proposed Atlantic Coast Pipeline.

Dominion is in good financial health and has a solid capital structure. Fishman expects the debt ratio to decline during the next few years as cash from operations increases, the company issues approximately $300 million per year in equity from its dividend reinvestment program, and over $2 billion of convertible securities convert to equity beginning in 2016. 

Analysts expect annual dividend increases in line with earnings growth, above 6%, during the next five years.

The third company stock in focus is the second-largest operator of wireless tower communication sites in the United States, holding nearly 40,000 towers: Crown Castle International (CCI).  

Crown now pays the highest dividend among the tower companies at 3.86%, equal to nearly 80% of adjusted funds from operations. The payout should enforce discipline on the firm as it allocates capital.

The firm sharply increased its dividend in late 2014 and plans to hold its payout to around 75% of adjusted FFO going forward. With the U.S. tower market largely rolled up at this point and Crown choosing to focus exclusively on this market, a high dividend payout makes sense, Morningstar analyst Michael Hodel said. The company is rated as a three-star fair valued stock by Morningstar analysts.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
CenterPoint Energy Inc27.61 USD0.22Rating
Crown Castle International Corp184.15 USD-1.72Rating
Dominion Energy Inc79.17 USD-0.73Rating

About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk