Vectren (VVC): A Utility Company with 57 Years of Uninterrupted Dividend Growth

You won’t read about Vectren in the headlines.

 

But for more than 50 years in a row, Vectren has quietly paid and raised its dividend. It’s a feat that’s been done by just 21 other companies publicly traded in the U.S.

 

Vectren is a utility company, and utility companies are often attractive to investors living off dividends in retirement. Their dependable earnings and defensive strategies mean their dividend payments are typically very safe.

 

But one downside of utility companies is their slow growth. Vectren’s growth, however, has accelerated as of late.

 

Let’s see if Vectren’s stellar track record of dividend payments and its growth potential makes it a candidate for our Conservative Retirees Portfolio.

 

Business Overview

Formed in 1999 as the merger of two Indiana utility companies (one of whose roots date back to 1912), Vectren serves natural gas and electricity to customers in central and southern Indiana as well as Ohio.

 

 

Vectren’s customers in these areas are a healthy mix of residents, businesses, and industrial complexes. In its core natural gas business, 67% of 2015 revenue was from residential customers, 23% from commercial customers, and 10% from industrial customers.

 

Like all utility companies in the United States, Vectren is regulated by the public utility commissions (PUC) of the states in which it operates. These commissions set the prices utility companies can charge.

 

Vectren also runs a non-regulated business that provides pipeline construction and repair services to other utility companies and, to a lesser extent, energy contracting for large institutions like universities.

 

These unregulated, non-utility services account for about 20% of Vectren’s business each year.

 

 

Business Analysis

“Location, location, location” is the mantra for most businesses. But for utility companies like Vectren, it’s “regulation, regulation, regulation.”

 

Enormous investments in infrastructure like generating stations and power lines are required to provide energy to people. As a result, competition in the industry is scarce, and were it not for regulation, utility companies would be able to charge exorbitant rates.

 

Thus begins the dance between regulators and utility companies. Regulators see to it that utility companies charge reasonable rates while also granting them the right to earn a profit.

 

This relationship between a utility company and its regulators is paramount. If poorly regulated, a utility company can fail. Pacific Gas & Electric, for example, declared bankruptcy in 2001 after California regulators refused a rate increase to compensate for soaring energy costs.

 

Thankfully for Vectren and its investors, the company has enjoyed a long history of favorable relations with regulators in Indiana and Ohio.

 

Most recently, Indiana approved Vectren’s 7-year gas infrastructure plan. Investments like these drive growth for utility companies, whose permitted revenues are tied to their “rate base”, or the value of their infrastructure. The higher Vectren’s rate base, the more revenue the company is afforded.

 

Vectren expects a 5–6% annual growth in their rate base over the next four years as a result of regulator-approved investments in infrastructure.

 

 

Regulators have also approved a pricing formula that includes adjustments for weather (warm winters beget less demand for energy) and the cost of natural gas and fuel, two factors that would otherwise cause uncertainty in Vectren’s profitability.

 

With the cost of living already below the national average in both Indiana and Ohio, there’s little reason to think that regulators in the two states will turn hostile towards Vectren and squeeze their profits.

 

But despite the friendly regulatory environment, Vectren’s utility business, like most utility businesses, grows slowly.

 

To grow faster, the company runs two non-regulated, non-utility businesses that promise higher profit margins: infrastructure construction and energy contracting.

 

Through its infrastructure construction business, Vectren sells pipeline construction and repair services to other utility companies. These days, demand is high as states across the country work to replace their aging gas infrastructure.

 

 

Vectren also does a wide-range of projects for large institutions through its energy contracting business. For example, the company recently won a contract to build a power plant at NASA’s headquarters.

 

Although the energy contracting business accounts for only a small fraction of total revenue, the company’s backlog of energy contracts has picked up significantly in recent years.

 

 

All said, Vectren’s blend of utility and non-utility business, along with favorable oversight by regulators, has meant the company has been more profitable than that of its peers in recent years. Vectren’s 5-year average annual return on equity sits at 10.2%, whereas popular utilities Consolidated Edison and Duke Energy have averaged 9.2% and 6% over the same period, respectively.

 

Key Risks

There’s little to be said about the stability of Vectren’s utility business. As a regulated monopoly, it has few competitors and enjoys undisturbed profits year in and year out.

 

What’s less certain, though, is whether Vectren can meet expectations to sustain its recent high rate of growth. If it can’t, the stock will likely disappoint.

 

Like all businesses, Vectren makes more money when the company sells to more customers. Vectren’s customers are the populations of Indiana and Ohio, both of which are forecasted to slow in growth.

 

 

 

Indiana’s rate of growth will slow substantially over the next few decades.

 

Decelerating population growth in Vectren’s service areas won’t likely impact the company in the short-term, but it may eventually put the brakes on the company’s current trend of higher growth.

 

Another obstacle to growth is energy efficiency. New lightbulbs, energy-efficient appliances, and other innovations may curtail the average person’s use of electricity.

 

In fact, the Energy Information Administration (a U.S. federal agency) projects that electricity use in U.S. households will rise 0.7% per year through 2040, a far cry from the 8% annual growth seen in past decades.

 

Another risk to consider is that Vectren’s non-utility business accounts for 20% of revenue, a larger percentage of sales than the non-utility businesses of most other utility companies we’ve researched.

 

This unregulated, non-utility business is competitive and cyclical, leaving Vectren more—though not much more—vulnerable to recession than some utility companies.

 

Finally, no analysis of a utility company these days is complete without a discussion on the implications of rising interest rates, a trend that may begin after years of a Federal Fund Rate close to 0%.

 

If interest rates rise, bond yields will follow. Since utility stocks are often viewed as bond alternatives because of their high dividend yields and stability, investors may choose to sell their shares of utility companies and instead invest in bonds.

 

Share prices will naturally fall if investors lose their appetite for utility stocks. In the extreme case, investors of utility companies may witness flat or declining share prices, as they did during the 1970s when interest rates were on the rise.

 

 

In sum, while there are few obstacles to a profitable future for Vectren, there’s a concern that the company cannot maintain its current rate of growth. There’s also a short-term concern for Vectren’s stock price resulting from the effects of rising interest rates on all utility companies.

 

Vectren’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Vectren has an excellent Dividend Safety Score of 75, indicating that a dividend cut is unlikely.

 

The safety of Vectren’s dividend starts with a consistent earning payout ratio (the percentage of profits paid as a dividend).

 

 

We generally prefer to see companies with payout ratios less than 50%. But companies like Vectren that exhibit consistent, predictable earnings need less room for error to pay their dividend.

 

 

Vectren’s utility business accounts for 80% of revenue, but management expects a disproportional 85–90% of the dividend to be covered by earnings from this stable, predictable business. That’s good news for investors seeking safe income.

 

Now, compared to most companies, Vectren has a lot of debt. Businesses will always make interest payments before paying shareholders, so the greater a company’s debt burden, the greater the likelihood that its dividend will be cut during hard times.

 

However, companies with consistent and predictable earnings like Vectren can comfortably carry more debt than other businesses.

 

Furthermore, utility companies require massive loans to fund their infrastructure projects, and relative to its peers Vectren’s balance sheet is spick and span.

 

 

For example, the utility industry average Nebt Debt / EBIT ratio—a measure of how much debt a company carries relative to earnings—is 6.2. Vectren’s Net Debt / EBIT ratio is 5.0, one indication that the company is more conservatively financed than its peers.

 

Standard & Poor’s, a credit rating agency, has rated Vectren a superb A-, and we see nothing to suggest the rating should be otherwise.

 

Vectren’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Vectren’s Dividend Growth Score of 51 is average and suggests the company will grow at about the same rate as the rest of the market.

 

Over the past 10 years, Vectren has increased its dividend at an average rate of 2.80% per year, well below the S&P 500’s average of around 6%.

 

 

More recently, though, Vectren has accelerated growth of its dividend to an annual average rate of 5.3% over the past 3 years.

 

 

Although 3 years doesn’t make a trend, management expects earnings to grow 5–7% per year over the next 5 years as a result of planned, regulator-approved infrastructure investments.

 

Vectren’s earnings payout ratio ratio over the past 12 months (65%) is already below its target (70%), so there’s good reason to believe Vectren can grow its dividend at its target rate.

 

Valuation

 

As good as the business is, Vectren is not cheap today. Its 3.06% yield is at its 5-year low, and its Price / Earnings ratio (22.2) is near its 5-year high.

 

Slower-growing utility companies Duke Energy and Consolidated Edison—both popular choices for investors living off dividends in retirement—trade at lower P/E ratios of 18.6 and 18.9, respectively.

 

It seems that investors are excited for Vectren’s growth potential and have bid up its share price in recent years. The price may be justified if Vectren can meet its growth targets long into the future, but any setbacks will likely leave investors who buy at the current price disappointed.

 

A prudent investor might wait to see Vectren meet its growth target for several more years before buying its stock at a premium to other slow-growing utility companies.

 

Conclusion

So is Vectren a candidate for our Conservative Retirees Portfolio?

 

The company has many of the qualities investors seek in retirement: a (stellar) track record of paying dividends, a dividend yield above 3%, moderate growth potential, and resistance to recession.

 

While we typically invest in companies much larger than Vectren, at the right price it would fall nicely into our portfolio. But today, its historically-low yield and high price leave us on the sidelines.