Forget about new paradigms, those futuristic structural changes that produced the tech bubble and that artful dodger, Enron Corp.
During their biggest rally since World War II, these utilities have been exiting their foreign investments, complex power trading operations and other ventures once considered their destiny.
Instead, they're upgrading power transmission, dealing with environmental issues and seeking regulatory approval of new plants. Their stocks, up 15 percent this year and outperformed only by energy stocks, also benefit from industrywide merger speculation.
"We're now in the third year of a back-to-basics strategy," said Michael Worms, electric utility analyst with Harris Nesbitt in New York. "In 2003, electric utilities restored their balance sheets that were heavy with debt from their past follies, and in 2004 they returned cash to shareholders through accelerated dividend growth or the resumption of dividend growth."
The underlying investor question is whether these stocks can continue their impressive run, or if good news is fully reflected in current prices.
Paul Fremont, an analyst with Jefferies & Co. in New York, is concerned that if optimism for the broader market grows by year- end, investors will yank money out of utilities and put it in stock sectors with greater potential.
Others disagree.
"Electric utility stocks have had a good run and, while they'll have pullbacks, our view is that their positive movement could continue long-term," said Robert Becker, senior vice president and co-portfolio manager of funds that include Cohen & Steers Select Utility Fund Inc., up 15 percent this year.
"A general low-return environment that could continue for years to come makes companies with predictable earnings and cash flow growth attractive, and that's utilities," Becker added.
Tax law changes in 2003 that gave investors a tax break on dividends helped energize the industry. Electric utilities, with an average yield of 3.6 percent, trail only real estate investment trusts in dividend yield. Low bond yields have helped utilities in their competition for conservative, income-oriented investors.
"Electric utilities have gotten the signal that investors want dividends, so we've seen increased payouts," said Charles Fishman, an analyst with A.G. Edwards & Sons Inc. in St. Louis, noting that rising earnings permit this shift. "While yields on long-term bonds remain low, utility stocks could provide exceptional total returns (price appreciation and dividends) of up to 10 percent over the next 12 months."
Some of the price appreciation is based on the new Energy Policy Act of 2005, which ends longtime geographic constraints that limited energy utilities to local markets and also permits ownership by non- utility companies. Mergers have begun. It also gives incentives for new investment in transmission, distribution and environmental equipment.
"These stocks have a high level of predictability and high yield, yet are trading at a discount to the broader market," said Fremont. "Electric utilities had an annual earnings growth rate of 2 (percent) or 3 percent over the past 15 years, but in the next three years the rate will be 7 percent."
Exelon Corp., the largest U.S. utility owner by market value, is Becker's top holding and is recommended by Fremont and Worms. The company's management has a track record of balancing shareholder and customer interests, they say, and will produce above-average dividend growth. Exelon also is in the process of buying Public Service Enterprise Group Inc. of New Jersey.
While nuclear power remains controversial on potential for accidents or acts of terrorism -- a new nuclear plant hasn't been commissioned in 30 years -- the Energy Policy Act provides incentives for nuclear power. A.G. Edwards' Fishman believes the two biggest players in nuclear energy, Exelon and Entergy Corp., would benefit if its low cost and ability to reduce greenhouse gasses gain public acceptance. He expects two or three nuclear plants will be built in the U.S. in the next decade, likely as units at existing plants.
Dominion Resources Inc. is recommended by Fishman and Worms in part because it has oil and gas as well as electrical businesses. Edison International, whose shares are owned by Becker and recommended by Fremont, should benefit from Southern California's need to expand its transmission grid and build more power plants.
Meanwhile, Fishman favors Florida Power & Light holding company FPL Group Inc. as an industry blue chip and solid core holding. Among other top Becker holdings, Duke Energy Corp. has capable new management helping it recover from previous poor investment in unregulated businesses, ex-perts said.
Let the mergers begin: Possible takeover candidates, Fishman said, could be Allegheny Energy Inc., Constellation Energy Group Inc., DPL Inc., Energy East Corp., FirstEnergy Corp., Northeast Utilities, NSTAR, PPL Corp., SCANA Corp. and Teco Energy Inc.
"But predicting mergers is difficult due to the human factors involved," Fishman cautioned. "The deals aren't always motivated by purely strategic reasons."
Andrew Leckey answers questions only through the column. Address
questions to Andrew Leckey, "Successful Investing," P.M.B. 184, 369- B
Third St., San Rafael, CA 94901-3581, or by e-mail at andrewinv@aol.com.
