Utilities Funds Turn into Power Players
Jun 10 - USA TODAY
If your 6-year-old has been slapping NFL quarterbacks across the room, then you know what it has been like watching utilities stocks this year.
Utilities are often called "widows and orphans stocks" --
investments so meek and mild that brokers could sell them to widows and orphans,
and no one would complain. They are highly regulated companies with dependable
earnings and strong dividend payouts. While they rarely electrify, they don't
short-circuit often, either.
The rally is more remarkable because it's done so in the face of rising
energy prices. If you want to generate electricity, you have to use energy of
some sort. Most energy companies use natural gas to fire their generators, and
the industrial price of natural gas has climbed to $7.22 per million British
thermal units (Btu) from $6.05 a year earlier. What's driving the utilities
rally?
*Dividends. Standard & Poor's electric utility index has a 3.5% dividend
yield, vs. 2% for the S&P 500. "There's a lot of hunger for yield by
investors," says Barry Abramson, utility analyst for the Gabelli funds.
*Dividends. Thanks to recent changes in the tax laws, qualifying dividends
are now taxed at 15%, rather than at your highest income tax rate.
*Dividends. Unlike bonds, which pay fixed interest each year, a utility
company can raise its dividend each year, and many do. If you buy a $10,000,
10-year Treasury note that pays $395 a year in interest, you'll collect that
$395 year after year for a decade. If you invest in a utility that raises its
dividend 4% a year, your yield will be 4.09% after a decade. Reinvest dividends,
and your payout will rise to $583 a year. Furthermore, your stock's price could
rise, as well.
In this dismal, low-rate environment, utility dividends look pretty good,
especially when compared with bonds and bank CDs.
But the rise in utilities stocks also reflects investors' fear of the future.
For example, there are those higher energy prices, which are often poison for
utilities.
Not this time. "High energy prices are creating a big cloud over the
economy," Abramson says. How is that good for utilities? Even in the worst
of times, people don't go without electricity, so investors figure that the
stocks are safe, even when the economy goes sour. Rising gas prices haven't kept
investors from utilities.
Rising short-term interest rates are traditionally poison for utilities, too.
Wall Street regards utilities as a bond with a college education. Bond prices
fall when interest rates rise, and traders often push down utilities when the
Federal Reserve Board pushes up rates.
Not this time. Investors seem to view utilities as a shelter from any
rate-induced economic slowdown.
Utilities have other charms in a downturn:
*Price. Despite their run-up, utilities are still attractively priced. The
S&P Electric Utility index carries an average 3.5% dividend yield, vs. a
3.95% yield for a 10-year T-note. That's well within their normal range.
Typically, utility stocks yield 80% to 90% of the 10-year T-note payout.
Many utilities also were clobbered when Enron, the Houston company,
collapsed. The industry's run-up started at a very low level. Last month,
billionaire Warren Buffett's Berkshire Hathaway holding company bought
PacificCorp for $5.1 billion, indicating that a few utilities are still cheap.
*Balance sheets. The Enron collapse prompted many utilities to return to
their core business -- generating energy -- and clean up their fundamentals.
Many regulators are allowing rate increases to improve transmission lines.
If you want to buy individual utility stocks, look for those that can
generate electricity with lower-priced coal or nuclear plants, says Matt Smith,
co-manager of the Franklin Utilities fund. "Their profit margins are much
better," he says. One favorite: Dominion Resources.
Abramson likes FPL Group. One plus: It's the biggest developer of wind power.
"They have wind power operations in more than a dozen states," he
says.
Eventually, utilities funds will stop slapping the S&P 500 across the
room. But at least for now, it doesn't look like that will happen any time soon.
John Waggoner's column appears Fridays. E-mail: jwaggoner@usatoday.com