Utilities Have Become The New CDs and Bonds For Income Investors

June 4, 2012 by Jon C. Ogg

We are mostly in a world where many investors are now just willing to settle for a “return of capital” rather than a “return on capital.”  Still, retirees and investors who rely upon income do not want to eat away at their cash balances while the government pays only 1.50% for a ten-year Treasury Note and only 0.65% for the five-year Treasury Note.  Certificates of Deposit are where investors have generally gone to find higher income in the past, but CD rates are often just 1% at best now and that is for a multi-year rate today.  The bond and CD investors are still moving into utility stocks to replace the income stream.

In many cases, investors can still get close to a 5% dividend yield in their utility shares.  The volatility is generally low, the income predictability is generally high, and utilities by and large are extreme beneficiaries of very low interest rates due to their borrowing costs being so low.  A 5% dividend from low-volatility and from proven models, or a 1.38% average CD yield on a five-year maturity (according to Bankrate.com)… if you are a retiree or an investor who has to live off of income from investments, it is easy to see why utilities are the next CDs.

The long and short of it is that this extremely low rate environment will force retirees and near-retirees to deplete their life savings just in order to live if they do not look elsewhere.  The trick is for investors to find the utilities where the dividend is safe ahead and those which generally have fairly low volatility.  To prove the point, the DJIA is down 10% from the 52-week high and has just gone negative for 2012.  Most of the major utilities are down only 2% or 3% from their 52-week highs and some have just hit those highs recently.

24/7 Wall St. has compiled a list of the key liquid exchange-traded funds and a closed-end funds for investors who want more diversification than just one company or a few companies.  We have also screened out three of the top electric utility stocks for retail investors that offer the following minimum criteria: $5 billion in market value, a 4% or higher yield, not trading at a 52-week high but also not down more than 10% from the highs to avoid the troubled players and which still have implied upside to the consensus analyst price targets from Thomson Reuters.

We have also included some of the key water utilities here this time.  The yields on average are about 1% lower, but they are still about double that of the 10-year Treasury.  Water utilities also have a near-zero chance of competition coming in from deregulation like the power companies have in some markets.  These are also investments that are considered highly appropriate for widows and orphans.

UTILITY ETFs & FUNDS  

The Utilities Select Sector SPDR (AMEX: XLU) is the key ETF for the sector and the $35.75 price is down only 1.3% from its 52-week high and its dividend average puts the basket at more than 3.9%.  The iShares Dow Jones US Utilities (AMEX: IDU) ETF has a higher price of $87.00 and it is almost 2.5% down from its 52-week high and has a slightly lower implied yield of about 3.5% based on the trailing dividend average and the current price. Reaves Utility Income Fund (AMEX: UTG) is a more volatile closed-end fund versus less volatile ETFs and it trades at more than an 8% NAV premium with its shares being down about 11% from its 52-week high, but it also pays out closer to a 6% dividend yield.

UTILITY & GENERATION COMPANIES  

American Electric Power Company (NYSE: AEP) trades at $38.32 and its shares are down about 8% from the 52-week high with an $18.5 billion value.  Still, analysts expect some $3.00 in upside and the dividend yield is 4.9%. If one company is vocal about protecting dividends and about going after regulators on forced expenses, it is AEP. Its shares are underperforming against highs due to forced plant closures and regulatory pressure as it tries to diversify further and further away from coal.

FirstEnergy Corporation (NYSE: FE) trades at $46.70 and analysts have almost $3.00 of projected upside to the stock with a $19.5 billion valuation.  Shares are down only about 3% from their highs and the implied dividend rate is 4.7%.  The company is diversified in power transmission, generation and competitive electric sales serving 6 million customers in six states in the mid-Atlantic region.

PG&E Corporation (NYSE: PCG) is in the volatile California markets, but it seems to weather all storms.  At $43.70 it has a market value of about $18 billion and it is down only about 3% from recent highs.  The dividend yield is also about 4.2%.

PP&L Corporation (NYSE: PPL) is around $27.50 and shares are down about 9% from the highs.  It currently offers a 5.2% dividend yield and its market value is $16 billion. It is lifting its payout, but investors may want to know that this is also a power producer in the United Kingdom as well so the risks here are evidenced in the higher payout. PP&L now serves more than 10 million customers since it has expanded in the United Kingdom.

WATER UTILITIES WIN  

American Water Works Company, Inc. (NYSE: AWK) is down only about 3% from its high with shares at $33.85.  It has a premium valuation even at only $6 billion in market value,it has a dividend yield of just under 3%, and analysts expect nearly 8% price appreciation. This is one of our stocks to own for the next decade because of its geographic footprint with so many local monopolies.

Aqua America Inc. (NYSE: WTR) just hit a new 52-week high of $23.40 and shares are still above the prior high of $23.32.  Analysts have almost $2.00 of upside expected and the yield is closer to 2.8% because its stock has risen.

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Read Also: Junk Bond Spreads Reaching 700 Basis Points… How High Can They Go?

This is the current ‘best of list’ for higher dividends from the great utility sector. Perhaps the biggest question to ask is whether or not the dividend tax rates will go up enough in 2013 to matter.  So far, investors are voting with their pocketbooks that this will not be as bad as many fear.  Many of the key utilities trade very close to or even above their consensus price targets.   This sector has been given the promise of a very low interest rate environment ahead and these typically pass the suitability standards for the “widows and orphans” classification in stocks. Utilities are still the new CDs and bonds for investors who require some income from their investments.

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JON C. OGG