Is it time to turn a bit defensive with your allocation? It has been a shaky start to 2024 as valuations remain a concern amid a creep higher in interest rates to kick off January. The utilities sector was hit hard by steeper borrowing costs and a macro environment favoring mega-cap tech in 2023 and high-risk segments late last year.
I see an opportunity in shares of Duke Energy (DUK, Financial). The stock is undervalued, in my opinion, and the technical situation pairs well with the bright fundamentals right now.
One-year returns: Utilities post lackluster results
Company description
According to Bank of America Global Research, Duke Energy operates as a regulated utility in the Mid-Atlantic region of the United States. It runs regulated utilities in the Midwest, Florida and the Carolinas while supplying electric service to more than 7.5 million customers across the residential, commercial and industrial segments. Duke owns more than 50 gigawatts of capacity in the U.S. and operates gas utilities to more than 1.6 million customers, primarily in the Carolinas and Ohio. It also has renewable energy assets across the country.
Key data
With a $77 billion market cap, the North Carolina-based electric company within the utilities sector trades at a below-market 17.8 forward non-GAAP price-earnings ratio and pays a high 4.1% forward dividend yield as of Jan. 8. Ahead of earnings due out in February, shares trade with a low 16.3% implied volatility percentage while short interest on the stock is modest at just 1.3%.
Color on the quarter
Back in November, Duke reported mixed quarterly results. Third-quarter non-GAAP earnings per shareof $1.94 beat the Wall Street consensus forecast by 2 cents, but revenue of $8 billion, up 2% from the same period a year ago, missed by a material $150 million. The management team narrowed its 2023 adjusted earnings per share guidance range to $5.55 to $5.65 compared with the consensus forecast of $5.61. It also reaffirmed its robust earnings per share growth rate in the 5% to 7% range through 2027. Shares wobbled following the report, but the stock ultimately trended higher into the end of the year.
Key upside catalysts include expected growth driven by the approval of rate increases at Duke Energy Progress and Duke Energy Carolinas in North Carolina. Other regulatory decisions are expected in Kentucky, South Carolina and Florida β those will be important to monitor in upcoming earnings releases. Favorable demographic trends in the Mid-Atlantic and Southeast should be tailwinds for this high dividend yield company. Moreover, its gradual shift toward decarbonization should result in limited regulatory risks in the years ahead.
Helping Duke's rally in the fourth quarter was an upgrade by analysts at Wells Fargo β the team cited a multiyear restructuring and a long runway of capital investment over the coming years, which should help drive earnings power.
Competitor analysis
Compared to its peers, Duke features a decent growth trajectory, though other higher-risk sector companies may grow earnings faster. Its valuation is about in line with its primary competitors, particularly those in the Southeast. Duke stands out, though, with strong profitability and a high dividend yield. Furthermore, share price momentum is healthy, though earnings per share revisions have been negative in the last few months despite the bottom-line beat in November.
Investment risks
Key risks include poor rate case outcomes, operational errors that could negatively impact earnings and operating expenses, volatile interest rates and unfavorable policy changes in key operating markets.
Valuation
On valuation, analysts at Bank of America see earnings rising at a solid pace this year β up 8% is a healthy advance for a utility company. Per-share profits are then expected to moderate to a 6% growth rate in the out year. The current consensus forecast suggests a steady 6% to 7% earnings per share annual advance through 2026, while revenue is seen climbing at a low to mid-single-digit rate.
Dividends, meanwhile, are forecasted to rise at a pace commensurate with earnings growth while Duke's free cash flow yield is negative (that is common and expected with large utility companies given their high annual capital expenditure requirements). With steady and somewhat impressive operating earnings per share growth over the coming quarters, the stock's below-market price-earnings ratio appears attractive.
If we apply Duke's five-year historical 18.1 forward non-GAAP earnings multiple and assume normalized earnings of $6.05 per share, then shares should trade near $110, making this defensive play about 10% undervalued. While not a major discount to what I consider to be intrinsic value, Duke's modest beta and high yield are compelling factors when forming a diversified portfolio.
Duke: Earnings, valuation and free cash flow forecasts
Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed fourth-quarter 2023 earnings date of Thursday, Feb, 8. No other volatility catalysts are seen on the calendar.
Corporate Event Risk Calendar
The technical take
With steady earnings growth seen in the quarters ahead, Duke's technical picture has turned positive recently. Notice in the chart below that shares broke out from a descending triangle pattern that began around the stock's all-time high notched in the second quarter of 2022. A series of lower highs then came about β shares hit a multi-year low under $84 in October of 2022, right when the S&P 500 touched its bear market nadir. While bears came about on several occasions, when Duke hit its falling 200-day moving average, a double-bottom pattern helped to confirm support on the chart - $83 held on a retest of the low this past October.
The bullish move came over the final weeks of 2024. Take a look at the price thrust, accompanied by high volume, into year-end. Shares rallied through the 200-day moving average, pausing at the April 2023 peak near $100. Today, a bullish golden cross pattern is in play β whereby the shorter-term 50-day moving average crosses above the longer-term 200-day moving average, suggesting the bulls have regained control of the trend. Also, the 200-day MS looks to be turning higher in its slope, another bullish sign. With strong relative strength index momentum, evidenced at the bottom of the chart, I see upside potential. Based on the height of the descending triangle pattern, a measured move bullish target to about $120 is in play.
Overall, Duke's chart is constructive with about 20% of upside ahead while the low $90s is support in my view.
Descending triangle breakout targets $120, shares rally through the 200-day ma
The bottom line
I see both fundamental and technical upside to Duke. With steady profitability and operations, I calculate shares as about 10% to the cheap side while technical momentum is constructive.
