Black Hills Tempers Growth Expectations, But Dividend Remains Well Covered

Higher interest rates and elevated natural gas prices pushed Black Hills, the gas and electric utility operator, to lower guidance for the year ahead – leading the stock to drop almost 10% on Wednesday.

The bad news centered on the company's rising interest costs after a sharp rise in natural gas prices was absorbed by the firm and financed with variable-rate short-term debt.

Black Hills is allowed to recover all of these gas purchase costs through rate adjustments over time, but this regulatory lag means it will take 12 to 18 months until this incremental debt is paid down.

Black Hill's interest expense is expected to reach as high as $185 million this year, $15 million more than previously guided. 

Furthermore, the utility operator, with services in eight primarily western states, including Colorado, Wyoming, and Montana, has about $1 billion in debt maturing over the next two years that will likely be refinanced at higher rates.

Similar to other regulated utilities, Black Hills maintains a high debt load but still earns a BBB+ credit rating that reflects the stability of its cash flow.

This sensitivity to higher interest rates led the utility to lower guidance for annual earnings growth to 4% to 6%, down from the previously forecasted 5% to 7% range.

With slower growth expected over the next few years, today's sell-off may have been driven by investors shifting attention to other regulated utilities with similar yields but stronger balance sheets, like WEC Energy and Evergy. 

While we'd prefer if Black Hills had less debt, the firm's reliable cash flow stream, with nearly all revenue derived from regulated activities, is still expected to grow.

This dependable income stream has allowed Black Hills to grow its annual dividend yearly since 1971. And the company remains firmly committed to its payout and growth streak. 

Still, dividend growth will likely slow over the next few years to low single-digit raises until the balance sheet improves and earnings growth picks back up.

Overall, we are reaffirming Black Hills Safe Dividend Safety Score given there's no apparent looming disruption to the firm's reliable cash flow stream, and the current interest rate headwinds result in a still reasonable payout ratio near the high end of management's updated 55% to 65% target range.

Today's market reaction should not signal a need for conservative investors to sell their shares. While dividend growth will likely slow in the near term, the payout should remain a dependable source of income.

We will continue to watch for changes in Black Hill's payout ratio and deleveraging progress, providing updates as needed.