Today we have seen a diverging set of calls in the utility sector.  Bank of America Merrill Lynch has issued a somewhat cautious outlook, while Credit Suisse has talked up the risk-adjusted returns.  This is on the heels of a deep value and growth screen we ran on Exelon Corporation (NYSE: EXC); Entergy Corporation (NYSE: ETR); American Electric Power Co., Inc. (NYSE: AEP); and Public Service Enterprise Group Inc. (NYSE: PEG) as those utilities averaged dividend yields of close to 5%, were all large-cap, were down for the year so far, had operating margins of 15% or more, and a return on equity of at least 10%.

Credit Suisse’s outlook noted that there are still plenty of risk adjusted returns with the regulated utility group offering annual rates of return of 7% to 11%.  The breakdown is roughly 3% to 7% in earnings per share plus the $% to 5% in the dividend yields.  And on the risk side of the equation, CRedit Suisse sees a beta range of only 0.6 to 0.7 for the group.  The firm noted that this is a very compelling return in a low interest rate environment and fundamentally against the S&P 500 Index that would “require a minimum growth rate of 7% plus the 2.1% dividend yield to match the Utility stocks.”

Bank of America gave an earnings preview for the first quarter for utilities and brought up no winter, low earnings, and updating gas curves.  The mild weather is expected to drag down first quarter utility earnings by 6%.  The low natural gas price adjustments have been ratcheted down significantly from 2012 to 2014.   NV Energy, Inc. (NYSE: NVE) is noted as being expected to have a large dividend hike.

BofA also noted that Calpine Corporation (NYSE: CPN) has risen sharply and NRG Energy, Inc. (NYSE: NRG) and GenOn Energy, Inc. (NYSE: GEN) have both dropped sharply on the coal/gas switching theme, but the firm’s take is that the stocks may be extended too far on both sides as it does not see much change in guidance from any of the three companies.

It is always interesting when you see different calls when the same data is available.  It is a part of what makes a horserace.

JON C. OGG

24/7 Wall St. has formed a screening on the sector to see which high-yielding utilities may have finally priced in the worst of the news. We ran a screen on Finviz.com looking for the best of the best utilities. In our screen, we chose the following criteria:

• Market cap of $5 billion or more
• Daily trading volume of at least 1 million shares
• Dividend yield of 4%
• Year-to-date stock performance was negative
• Return on equity was at least 10%
• Operating margin of 15% or more
• Debt-to-equity under 1.4-times

The Utilities Select Sector SPDR (NYSE: XLU) managed to close up 0.6% at $34.87. Our screen turned up only four of the following utility leaders, with the key criteria being by dividend yield (highest to lowest): Exelon Corporation (NYSE: EXC); Entergy Corporation (NYSE: ETR); American Electric Power Co., Inc. (NYSE: AEP); and Public Service Enterprise Group Inc. (NYSE: PEG).

With the fear of rising interest rates ahead and higher dividend taxes, investors have tended to shy away from the steady earnings, yields and returns of utilities. The two questions that might matter the most are: 1) What if rates do not rise as much as investors hope? And 2) What if dividend taxes are not going to rise to over 40% for the high-income earners? Another question to ask is: What if the regulatory climate lightens up a tad against the utility sector? If one or two of these possibilities start to become reality, then there may be a huge opportunity in this sector. Even if these issues remain, it may be that most of the bad news is getting close to being factored in.

Exelon Corporation (NYSE: EXC) is the leader of the pack due to its 5.55% dividend yield. It has a market cap of $25 billion and trades more than 7 million shares per day. Year-to date its shares have fallen by 11.6%. The utility’s return on equity was listed as 17.9%, its operating margin is 23.6% and its debt-to-equity ratio was less than 1 at 0.94. Exelon closed up 0.6% at $38.06 against a 52-week range of $37.48 to $45.45.

Entergy Corporation (NYSE: ETR) has a market cap of $11.7 billion and trades 1.2 million shares per day. It has a dividend yield of 5% and year-to date its shares have fallen by 8.4%. The utility’s return on equity was listed as 15.4%, its operating margin is 17.9% and its debt-to-equity ratio was 1.34. Entergy recently closed up 0.5% at $66.43 against a 52-week range of $57.60 to $74.00.

American Electric Power Co., Inc. (NYSE: AEP) has a market cap of $18 billion and trades 4.9 milllion shares per day. It has a dividend yield of 5% and year to date its shares have fallen by 7.5%. The utility’s return on equity was listed as 11.1%, its operating margin is 18.4% and its debt-to-equity ratio was 1.24. Shares closed up 0.5% at $37.97 and the 52-week range is $33.09 to $41.98.

Public Service Enterprise Group Inc. (NYSE: PEG) has a market cap of $15 billion and trades 3.6 milllion shares per day. It has a dividend yield 4.9%. Year to date, its shares have fallen by 8%. The utility’s return on equity was listed as 14.1%, its operating margin is 24.4% and its debt-to-equity ratio was the lowest of the group at only 0.80. Public Service Enterprise closed up 1% at $30.33 against a 52-week range of $27.97 to $35.48.

What is interesting about this group is that AEP is the only member of the four that is not down more than 10% from its 52-week high, and all of these are closer to their 52-week lows than their highs.

JON C. OGG

American International Group (NYSE: AIG) Reiterated Buy with $40 target at BofA/ML.

Comerica Incorporated (NYSE: CMA) Cut to Sell at Citigroup.

CNO Financial Group, Inc. (NYSE: CNO) Started as Buy with $9 target at Goldman Sachs.

Deere & Co. (NYSE: DE) Reiterated Buy with $104 target at BofA/ML.

Dril-Quip, Inc. (NYSE: DRQ) named as Bear of the Day at Zacks.

Google Inc. (NASDAQ: GOOG) Reiterated Buy with $730 target at Argus.

Huntington Bancshares Incorporated (NASDAQ: HBAN) Started as Neutral at Citigroup.

Jefferies Group, Inc. (NYSE: JEF) Raised to Buy at Rochdale Securities.

KeyCorp (NYSE: KEY) Raised to Buy at Citigroup.

NVIDIA Corporation (NASDAQ: NVDA) Started as Buy at Cantor Fitzgerald.

Oriental Financial Group Inc. (NYSE: OFG) named as value stock of the day at Zacks.

Panera Bread Company (NASDAQ: PNRA) Started as Outperform with $190 target at Credit Suisse.

Pandora Media, Inc. (NYSE: P) Started as Underweight at Barclays.

Public Service Enterprise Group Inc. (NYSE: PEG) Reiterated Buy with $40 target at Argus.

Regions Financial Corp. (NYSE: RF) Started as Neutral at Citigroup.

URS Corporation (NYSE: URS) Reiterated Underperform with $49 target at BofA/ML.

Veolia Environnement (NYSE: VE) Cut to Sell at Deutsche Bank.

Zumiez, Inc. (NASDAQ: ZUMZ) named as Bull of the Day at Zacks.

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JON C. OGG

After the group of utilities we have added some color on why these stocks are performing the way they are, what the upside could still be, and other macro issues.  To show how bad the group has been with many of its top components down about 10% from their recent highs, the Utilities Select Sector SPDR (NYSE: XLU) is down almost 3.5% from its recent highs.

American Electric Power Company (NYSE: AEP) trades around $38.00 and the stock is down from a 52-week high of $41.98.  Its dividend now screens out at roughly 5% and the consensus analyst price target is $41.67.  AEP trades at 12.1-times expected 2012 earnings estimates.  While it may have had an issue over rate hikes in Ohio, this one is very diversified and our take is that the fears of its coal plants may have gone too far as analysts are playing tug of war.

Constellation Energy Group, Inc (NYSE: CEG) trades around $36.40 and the stock is down just from a 52-week high of $40.97.  Its dividend now screens out at roughly 2.6%, which has been under our dividend criteria for this sector.  The consensus analyst target is $41.25.  Constellation trades at 15-times expected 2012 earnings estimates.  This one is outside of our parameters except that it was down the most in the Finviz.com screen on a year to date basis.

Exelon Corporation (NYSE: EXC) trades around $39.20 and the stock is down just over 10% from a 52-week high of $45.45.  Its dividend now screens out at roughly 5.3% and the consensus analyst price target is $43.65.  Exelon trades at 12.9-times expected 2012 earnings estimates.

Public Service Enterprise Group (NYSE: PEG) trades around $30.65 and its stock is down over 13% from its 52-week high of $30.65.  Its dividend yield is about 4.7% and the consensus price target is $33.07.  This one trades at about 12.7-times expected 2012 earnings estimates.

The good news on coal is that prices are cheap.  Ditto for nat-gas.  The bad news is that the EPA and other pressuring forces are trying to move to less coal in a manner which may be too fast.  AEP and others in this sector are already lobbying to alleviate some pressures.

You see that the ones we generally prefer tend to have dividend yields of close to 5%.  This sounds great and it is better than our median targets in our 2012 Model Dividend Portfolio of which AEP is a member.  One critical issue is that Obama’s dividend tax aspirations could significantly lower the need to chase yield among the high-income earners in America.  Could the wealthy dividend investors feel crowded out of income stocks?

Oil prices have risen enough that if they remain high you should just expect that the rest of the energy basket will rise.  Can nuclear really get a foothold ahead?  We think so, but it won’t happen overnight.

There are two more pieces of macroeconomic bits working in favor of these utilities.  Unemployment is getting better and that allows younger workers to go out and rent houses, townhouses, or apartments.  The U.S. is not appearing to slide into a new recession as so many investors believed was happening in late-2011.  Overall business activity is holding up, and that in turn means more electric power consumption.

The downside of the better economy is that the current environment is favoring a “risk-on” mentality among investors.  In a climate of risk-on, investors want growth over safety in dividends with earnings stability.

The reversal in Ohio is far from a welcome wagon and we have seen some ratings agencies weigh in that this could impact some utilities.

After it is all said and done, investors have to always pick their poison.  Many of these great companies almost never pull back more than 10% from their highs except in points of market crisis or in a real bear market.  When that happens, investors who want equity exposure at least increase their weighting in utilities because of the high yields and defensive stock positions.

What poses the biggest risk to utilities in our view?  Another 10% market rally ahead of continued recovery.

Picking an exact bottom is a fool’s game.  You probably haven’t seen the exact bottom on the utility sector, but these are getting very close to being true bargains for investors with a long-term investing outlook in what is likely to still be a low-growth environment.

JON C. OGG

Allstate Corporation (NYSE: ALL) Started as Outperform at Credit Suisse.
Amazon.com Inc. (NASDAQ: AMZN) Started as Hold with $225.00 price target “due to low margins through 2012″ at Canaccord Genuity.
The Blackstone Group LP (NYSE: BX) Raised to Buy with $20.00 price target at Argus.
CenturyLink, Inc. (NYSE: CTL) named as value stock of the day at Zacks.
Chubb Corporation (NYSE: CB) Started as Outperform at Credit Suisse.
Darden Restaurants Inc. (NYSE: DRI) Cut to Hold from Buy at Argus.
Freescale Semiconductor Inc. (NYSE: FSL) Reinstated as Outperform at Credit Suisse.
GeoResources, Inc. (NASDAQ: GEOI) Started as Buy with $43 price target “on a concentrated Eagle Ford/Bakken exposure” by Canaccord Genuity.
Google Inc. (NASDAQ: GOOG) was initiated with a ‘Buy’ rating and $725.00 price target “on robust growth and great value” by Canaccord Genuity.
JDS Uniphase Corporation (NASDAQ: JDSU) Started in new coverage as Buy with a $14.75 price target at Jefferies.
LinkedIn Corporation (NYSE: LNKD) Started as Buy with $85 price target as “growth trumps valuation” by Canaccord Genuity.
Peabody Energy Corporation (NYSE: BTU) Downgraded to Neutral from Buy with $43 price target by Goldman Sachs.
Public Service Enterprise Group Inc. (NYSE: PEG) Downgraded to Neutral from Buy with $33 price target at Goldman Sachs.
Quest Diagnostics Inc. (NYSE: DGX) Started as Hold with $51 target at Auriga.
The Talbots, Inc. (NYSE: TLB) maintained Neutral with $3.00 fair value by Janney Capital Markets.
Travelers Cos. Inc. (NYSE: TRV) Started as Outperform at Credit Suisse.
Unisys Corporation (NYSE: UIS) Raised to Outperform as Bull of the Day at Zacks.
UnitedHealth Group Inc. (NYSE: UNH) added to the US Focus List at Credit Suisse.
Urban Outfitters, Inc. (NASDAQ: URBN) Maintained Neutral with $23.00 price target at Janney Capital Markets.
Willis Group Holdings, PLC (NYSE: WSH) named Bear of the Day at Zacks.

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Question: What is your investment process and how do you derive value today?

Our process seeks to uncover value stocks in virtually any market, including the volatile markets of today. The process includes three steps:

• 1. Screen for financially sound large cap companies with rising revenues, rising earnings, low debt to equity, favorable price to earnings, and favorable price to book ratios.
• 2. From that group, select only dividend paying stocks.
• 3. Add a covered call strategy on all stocks in the portfolio, to supplement cash from dividends.

Question: How does covered call strategy help in volatile market?

Our covered call strategy is more art than science. What it does is protect the downside somewhat at the expense of full participation in a large upside. We write calls on about a third of each of the stocks in our portfolio. We track our stocks to see if their movements reflect what the wider market is doing or if a stock is really going down on its own. In the latter case, we may dump the stock, but our loss is buffered by the covered calls we have issued in the past.

Question: When you screen for value, which two sectors are you finding to be the best?

The insurance sector and the consumer products sector present good value today. The energy sector is also displaying several stocks with good value.

Question: What are three of your top value stock picks and why?

We like Chevron Corp. (NYSE: CVX), Public Service Enterprise Group Inc. (NYSE: PEG), and Raytheon Co. (NYSE: RTN). Each of these stocks meets all our criteria (rising revenues, rising profits, low debt-to-equity, favorable P/E ratio and favorable price/book ratio) and each pays a nice dividend. Chevron’s dividend yield is 3.0%, Public Service Enterprise’s yield is 4.2%, and Raytheon’s is 3.4%.

Question: Raytheon seems like a risky recommendation, given the proposed cut of $400 billion in defense spending over the next 12 years.

We think that Raytheon is a good solid value, though perhaps more a tortoise than a hare. Its P/E is around 10 and its price-to-book is less than 2. We’re comfortable with those numbers.

Question: The fund also invests heavily in oil field services stock, which had a blowout year in 2010. This year the sector is doing considerably less well. Do you see some changes to the portfolio because of that?

Because we do a bottom-up analysis of our stocks, we don’t consciously try to overload on one sector or another. We hope for diversity, but we don’t push it. The oil field services sector is still a bread and butter area for us and we’ll stay with the stocks as long as they continue to pay dividends and as long as we don’t feel that they’re hurting our investors.

Question: With second quarter’s earnings season due to start next week, we’d like to know where you stand on second-quarter earnings and what’s your outlook on guidance?

We believe that corporate earnings will continue to show strength as a result of belt tightening, cost cutting, and debt reduction by many well-managed companies. Earnings will not reach record levels, but steady improvement will gradually lead us out toward full recovery — although we still have a long way to go.

Question: Value stocks fell victim to the recession just like the growth stocks, but do you expect them to hold up better than growth stocks and broader indexes (DJIA and S&P500) if the market rolls over again?

Value stocks will definitely hold up better in downside markets and volatile markets, especially stocks in those companies that pay dividends. When full recovery comes, growth stocks will probably be leaders on the upside. But as I said, we still have a long way to go before full recovery occurs.

Question: . Are there any special situations (M&A, spin-off, reorganization, etc.) out there that the market is either discounting entirely or has overlooked?

We assume continued market volatility for the forseeable future. We don’t know what will by the next Greek economic crisis, the next Japan earthquake disaster, the next Egypt or Libya political unrest, or how the politicians in our own country are going to handle the debt ceiling crisis, as well as the continued need for economic stimulus.

Therefore, we choose to stay the course and find good financially sound companies, who pay dividends and control their own debt. Special situations worry us because they involve too many unknown factors, which could be adversely impacted by the volatility flowing from whatever might be the next crisis.

Question: What do you mean when you say that more economic stimulus is needed?

I don’t necessarily mean a third round of quantitative easing. That’s a political question, and I don’t have a crystal ball that gives me any special insight into how that kind of question will be resolved.  But I will say that the future of the US economy depends on creating new jobs in the private sector. That will require capital investment on the part of US companies, and that will create more jobs and more spending.

Interview by Paul Ausick

Apple Inc. (NASDAQ: AAPL) Reiterated Overweight and $340 target at Barclays.
Applied Materials Inc. (NASDAQ: AMAT) Cut to Underperform at First Global.
Avago Technologies Limited (NASDAQ: AVGO) Reiterated Buy and $30 target at Gleacher.
China Medical Technologies Inc. (NASDAQ: CMED) Started as Buy with $16 target at Deutsche Bank.
Dominion Resources, Inc. (NYSE: D) Cut to Underweight at Morgan Stanley.
Family Dollar Stores Inc. (NYSE: FDO) Cut to Market Perform at BMO.
Intuitive Surgical, Inc. (NASDAQ: ISRG) Raised to Outperform at Wells Fargo.
Medtronic, Inc.(NYSE: MDT) Cut to Market Perform at Wells Fargo; Cut to Market Perform at William Blair.
Online Resources Corp. (NASDAQ: ORCC) Raised to Outperform at Oppenheimer.
Public Service Enterprise Group Inc. (NYSE: PEG) Cut to Underweight at Morgan Stanley.
Qlik Technologies, Inc. (NASDAQ: QLIK) Started as Buy at Jefferies.
RealD Inc. (NYSE: RLD) Started as Outperform By BMO; Started as Overweight at Piper Jaffray; Started as Overweight at JPMorgan.
Research in Motion Ltd. (NASDAQ: RIMM) Cut to Hold an $48 target at GMP.

You can join our free daily email distribution list to hear more about dividend trends, analyst upgrades and downgrades, top day trader and active trader alerts, news on Buffett and other investment gurus, IPOs, secondary offerings, private equity, and more.

JON C. OGG

Affymetrix Inc. (NASDAQ: AFFX) Cut to Underweight at Piper Jaffray.
The Andersons, Inc. (NASDAQ: ANDE) Raised to Buy and $41 target at BB&T.
Charm Communications Inc. (NASDAQ: CHRM) Started as Outperform at Credit Suisse.
FirstEnergy Corp. (NYSE: FE) Cut to Hold at Citigroup.
The Mosaic Company (NYSE: MOS) Maintained Hold but Target cut to $45 from $57 at Soleil.
OpenTable, Inc. (NASDAQ: OPEN) Cut to Hold at Citigroup.
Potash Corp. of Saskatchewan (NYSE: POT) Maintained Hold but Target cut to $89 from $100 at Soleil.
ProLogis (NYSE: PLD) Raised to Market Perform at Wells Fargo.
Public Service Enterprise Group, Inc. (NYSE: PEG) Added to Conviction Buy List at Goldman Sachs.
QuinStreet, Inc. (NASDAQ: QNST) Raised to Overweight at Thomas Weisel.
Wimm-Bill-Dann (NYSE: WBD) Added to Focus Sell List at Goldman Sachs.

You can join our free daily email distribution list to hear more about dividend trends, analyst upgrades and downgrades, top day trader and active trader alerts, news on Buffett and other investment gurus, IPOs, secondary offerings, private equity, and more.

JON C. OGG

Petra Solar is a South Plainfield, New Jersey-based company which designs and manufactures the SunWave™ solar electric system for utility, commercial, and residential installations. These systems scale from a single panel to multi-megawatts, and the company calls this “the most deployable, cost effective and intelligent solar solutions in the industry.” Petra said that the contract is about $200 million to it over a three-and-a-half year period with PSE&G, and it will make the units for the 200,000 poles under the agreement.

This effectively doubles New Jersey’s solar capacity.  The agreement was reached in its” Solar 4 All” filing, and PSE&G noted that it expects to complete the installations by the end of 2013.  It shall come in two segments of 40 megawatts each. The first segment consists of installing a solar unit on some 200,000 utility poles in PSE&G’s service territory, including New Jersey’s six largest cities and roughly 300 rural and suburban communities.

Petra Solar will be producing 200,000 smart solar systems for installation on the PSE&G utility poles and street light poles.  This is said to be the largest pole-attached solar installation in the world.  Petra is creating more than 100 green jobs from this pact.  The company called this a transformational contract that will triple its size.

Interestingly enough, this is a grid-connected solar system that will more easily enable PSE&G to delivery of electricity to customers.

JON C. OGG
JULY 29, 2009

The new OUTPERFORM rated stocks are American Electric Power Co., Inc. (NYSE: AEP), Duke Energy Corporation (NYSE: DUK), Exelon Corporation (NYSE: EXC), PG&E Corp. (NYSE: PCG), Public Service Enterprise Group Inc. (NYSE: PEG), UNITIL Corporation (NYSE: UTL), Xcel Energy Inc. (NYSE: XEL).

The new more cautious PERFORM rated stocks are Consolidated Edison Inc. (NYSE: ED), FPL Group Inc. (NYSE: FPL), Pinnacle West Capital Corp. (NYSE: PNW), Progress Energy Inc. (NYSE: PGN), SCANA Corp. (NYSE: SCG), and Southern Company (NYSE: SO).

There are others that may not be included in the list today, but this is a brief summary from early this morning.  To show how the lot of utilities has performed, we looked at the iShares Dow Jones US Utilities (NYSE: IDU) ETF that tracks the sector. It closed at $67.25 yesterday, and its 52-week range is $53.15 to $100.98.

While the number of houses being foreclosed or are vacant has stayed high, that should start to abate over the next six months.  And if the economy’s green shoots start to turn into some small visible growth toward the end of the year or into next year, then the power consumption from major corporate and industrial clients should start to pick back up as well.

Many of these utilities have also underperformed in the ‘defensive stocks’ category.  This recession led to enough home foreclosures and power reduction from the industrial and manufacturing sector that it took out at least some of the stability or safe harbor characteristics of the past.  It looks like Oppenheimer expects this to improve at least some from here on out.

Jon C. Ogg