Last week I received a couple of great questions, and I felt they were important enough to share with readers. So with permission, I’ve posted the second of two questions. I also invite your discussion as well, since ultimately we are all here to learn!
Why Do Utilities Have Such High Debt and High Payout Ratios?
I was however left curious about the relatively high DPR’s my utility holdings have. I own shares of FTS-T, ENB-T, and TRP-T which have DPR’s of 66%, 64%, and 87%. Their corresponding debt/equity ratios are 135%, 190%, and 126%. Are these high ratios something to be concerned about or do their relatively consistent and reliable earnings support the higher DPR’s and debt/equity ratios?
Generally utilities do have much higher DPR’s than their blue-chip counterparts. The basic reason being they are matured businesses with less room for growth or expansion. Therefore they tend to pay out more of their earnings or cash-flow as dividends to shareholders. That is the general rule anyway. So as an industry average, there are certainly higher DPR’s among utilities – though I’m not convinced 87% is healthy. Utilities also tend to have higher Debt-to-Equity ratios as well.
Ultimately you can’t compare Wal-Mart to Fortis, or Tim Horton’s to Enbridge. You have to look at the average in a given industry. So if you think TransCanada Corp. (TRP-T) has high debt and a high DPR, then you need to compare it to the average for most utilities, and make your comparison within that sector.
Regardless, I haven’t jumped on board with utility stocks as most of my dividend brother’s and sister’s have. I’ve always been a little wary of the higher DPR’s and higher debt ratios in this sector. In my opinion it just makes these companies more susceptible to economic shifts. There is always a trade-off for a slightly higher yield, isn’t there?
Food for Thought:
As mentioned a DPR and other ratios need to be compared within a sector, rather than the overall broad market, so one isn’t comparing apples to oranges. Throw in the complexity that some smaller companies base their payout ratios on Distributable Cash Flow instead of EPS, and it gets even more convoluted. This is something I cover in my November MoneySaver article.
However, to keep it simple here are some basic criteria to consider: (1) Is the dividend yield reasonable? (2) Does the company carry high debt? (3) Has the company reported positive or negative earnings?, and (4) Is the PE Ratio unusually high, or unusually low?
Readers what’s your take? Do you agree or disagree, or have anything you want to add?