If there was ever a contrarian trade for 2017, it would be the power-generating utility stocks. The sector had a huge run in 2014 and 2015 as investors crushed by low interest rates ran to the sector for safe dividend yields. But as rates started to creep higher in 2016, and with the specter of looming Federal Reserve increases, the selling started, and it was big.
Needless to say, despite the sector going out of favor, power generation is still a crucial infrastructure need for everybody in the United States, whether it be at home or for business. A new SunTrust Robinson Humphrey research report makes the case that there is still some value in the sector and offers five top ideas for this year that makes sense for more conservative accounts. All are rated Buy.
American Electric Power
This industry leader is also a solid dividend-paying company. American Electric Power Co. Inc. (NYSE: AEP) is one of the largest electric utilities in the United States, delivering electricity to more than 5.3 million customers in 11 states. It ranks among the nation’s largest generators of electricity, owning nearly 38,000 megawatts of generating capacity in the United States. It also owns the nation’s largest electricity transmission system, a more than 40,000-mile network that includes more 765 kilovolt extra-high voltage transmission lines than all other U.S. transmission systems combined.
Many on Wall Street feel that the stock trades at a discount to its utility peers and they feel it deserves a premium. The analysts note the company has a less volatile earnings stream, and they see the potential for earnings upside due to changes in legislation in Ohio. Also trading at a discount to peers could lead to a premium valuation.
AEP shareholders receive a 3.8% dividend. The SunTrust price objective for the stock is $81, and the Wall Street consensus target is $67.03. Shares closed on Tuesday at $62.12.
This company is an off-the-radar choice that has solid upside potential from current levels and is a top mid cap pick at SunTrust. AES Corp. (NYSE: AES) owns and operates power plants to generate and sell power to customers, such as utilities, industrial users and other intermediaries. The company also owns and operates utilities to generate or purchase, distribute, transmit and sell electricity to end-user customers in the residential, commercial, industrial and governmental sectors. It also generates and sells electricity to the wholesale market.
AES uses a range of fuels to generate electricity, including natural gas, coal, hydro, wind, energy storage, oil, diesel, petroleum coke, biomass, landfill gas and solar. The company owns and operates a generation portfolio of approximately 29,352 megawatts. It has operations in the United States, Chile, Colombia, Argentina, Brazil, Mexico, Central America, the Caribbean, Europe and Asia.
The analysts note that the company trades at a 26% price-to-earnings multiple discount to peers in the sector. They noted this in the report:
After 3 years of flat / declining earnings, earnings growth should align with cash flow (and dividend) growth, driven primarily by projects currently in construction. Resolution of Ohio regulatory application (expected in the first quarter of 2017) should provide visibility to earnings growth outlook.
AES shareholders receive a 4.25% dividend. The $15 SunTrust price objective compares with the consensus target of $12.34. The stock closed at $11.33.