Energy Business

Dividends or Not, Utilities Need To Perform (XLU, SO, D, DUK, FPL, AEP, ETR, FE, EIX, PGN, PPL, XEL, DTE, AES, CEG, NRG, CPN, AYE, NU, PNW, POM, NST, OGE, TE)

Jon C. Ogg

So what is working against utilities?  The big fear is rising rates and then the coming regulation of carbon emissions.  Rates are rising down the road, and utilities historically do better in low rate environments because they have to borrow long-term for building their infrastructure.  And it is hard to find many who do not believe that an emissions tax is coming.  If you burn coal or natural gas, you have emissions and the current climate is one of taxation regardless of which side of the aisle you are on.

But there are several things working here that may actually work in favor of the utilities.  By and large, the P/E ratios are under the market average, as most trade at an average of about 13-times earnings (more than a 10% discount to S&P).  They should be because they are not growth stocks.  The economy is recovering, and that means more power consumption from large electricity using companies and entities now that business is getting back to normal.  Housing has stabilized or at least gotten out of the death spiral.  And as bad as the labor market is, things are far less bad than they were two quarters ago.  The administration has decided to endorse nuclear power.  And the fear that energy prices will head through the roof is not present as much as it was.  That means that utilities do not have to worry about input costs automatically exceeding revenue per customer.

It is growing easy to find 4% dividend yields now in the utility sector.  Even the key Utilities Select Sector SPDR (NYSE: XLU) ETF, which has sporadic dividends due to the nature of ETFs and rolling dividend payments, has a dividend yield of more than 4% if you add up the last four trailing dividends and base it on today’s price.  And President Obama just sent out billions of dollars for the utilities to collectively do more for a smart grid and for alternative energy and more energy efficiencies.

Analysts are VERY mixed on utilities.  Last Thursday Citi gave Mirant Corp. (MIR), RRI Energy (RRI), and Public Service Enterprise Group Inc.(PEG)  “sell” ratings.  First Energy (FE), NRG Energy (NRG) and PPL Corp. (PPL) were cut to hold.  But this follows a rival’s huge upgrade last summer, and based upon the share prices there is not much difference.  NRG Energy (NRG) and FPL Group (FPL) were just started as “Buy” ratings at Wunderlich.

Still, many consensus analyst price targets by Thomson Reuters are well above the current prices.  And the defensive nature of these stocks should offer at least some support if that feared correction every comes that so many worry about either for valuations or for the fear of a rate inspired double-dip recession.  Many utilities are seeking rate hikes, and depending upon whom you ask or what your own outlook is there are some who feel much more consolidation may be coming in the sector.  Warren Buffett tried to snag Constellation, and many thought his “whale of a deal” would be in a utility rather than a railroad.

Some of these utilities offering the most upside to average analyst price targets are Calpine Corporation (NYSE: CPN); FPL Group, Inc. (NYSE: FPL); American Electric Power Company (NYSE: AEP), PP&L Corporation (NYSE: PPL), AES Corporation (NYSE: AES) (with international operations), NRG Energy, Inc. (NYSE: NRG), and Capine Corporation (NYSE: CPN).

We have shown a breakdown of these major utilities as follows: