Investing

Chasing High Dividends: Utilities Approaching Bargain Territory (AEP, EXC, CEG, PEG, XLU)

2011 was the year of the utility stocks offering investors high dividend yields of well over 4.0%.  2012 has not gone so well for the sector, with 25 of the 34 S&P 500 Index utilities down for the year in data from Finviz.com.  As it turns out, some are down worse than others.  A few of these are starting to look like bargains now that they are down about 10% from their 52-week highs.  We have highlighted the valuation, targets, and performance of American Electric Power Company (NYSE: AEP); Constellation Energy Group, Inc (NYSE: CEG); Exelon Corporation (NYSE: EXC); and Public Service Enterprise Group (NYSE: PEG).

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