Throwing the Baby Out With The Bathwater

Declan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Bears have done their bit to take the steam out of the mini-recovery last week, which has left Bulls on the defensive and looking down instead of up. However, there is one sector which is at risk from been thrown out with the bath water: Utilities.

The Utilities Select Sector SPDR (NYSEMKT: XLU) was the first sector to get beaten on by bears. After a rally which saw it advance from lows of $33.18 in November 2012, it managed to work its way up to a high of $41.44 in April 2013. It then got culled from the herd as its collapse came harder and faster than for any other sector. But things may be changing. The Utilities Select Sector SPDR was not the worst performing sector of the past week: this honor went to Energy, with Technology not far behind. Warren Buffett has been fishing in the sector with the proposed acquisition of NV Energy. And Utilities offer some of the richest yields of any sector, currently at 3.7%. The case for the Utilities Select Sector SPDR was made in an earlier post (and one from Mark Morelli), but what of some of the individual names in the sector?

Fracking for Opportunity

CenterPoint Energy (NYSE: CNP) is one of the strongest stocks in the sector, and is the best positioned to lead a recovery in the Utilities sector. I first featured the stock in March after it reported excellent earnings. Better still, the stock has held the ground earned from its earnings boost. With a P/E of 23.9 and a projected P/E of 17.7 it's trading ahead of the Utilities Select Sector SPDR P/E of 16.0, although broad weakness in the sector has depressed the latter. Its high debt loads are a possible concern, although the nature of business often requires utility companies to carry large levels of debt. Consequently, utility stocks usually perform better low interest rate periods (and suffer during high rate periods), hence their attraction during times of economic weakness. However, CenterPoint's Energy Total Debt/Equity of 211 is significantly greater than sector leader EQT’s (NYSE: EQT) 64, or a 121 of larger Southern Energy.

The High Flyer

EQT has been the most resilient of the Utility sector stocks, flirting near its 52-week high as other utility stocks collapsed around it. The stock is enjoying a second wind after the credit crunch ended a 10-year rally from 1998 to 2008, but action in 2013 has already seen the 2008 high exceeded. The company comfortable beat on Q1 expectations, but it's heading into its traditionally weak Q2 period. For a company with such strong price performance, its earnings history is somewhat erratic relative to expectations. It's hedging of Natural Gas prices had generated slightly lower than expected returns, but this weakness was handily offset by higher volumes: up 47% over Q4 volume; its Marcellus Shale play contributing a 103% year-on-year growth. However, this growth is attributable to fracking, of which EQT is the dominant player in the Marcellus Shale region (sidenote: there wasn't a single mention of fracking in the latest earnings call by executives or analysts). For opponents of fracking, this rapid growth is a concern, but such growth will not be sustainable if fracking was to attract increased regulation and/or additional class action suits.

EQT also noted a year-on-year boost from what was termed a more "normal" winter; according to their NOAA reference, Q1 of 2012 was the "warmest on record". CenterPoint Energy's gas operations similarly benefitted. Consequently, Q1 was an easy beat on expectations for gas utility companies. Q2 will offer a stiffer challenge. As a seasonally weaker quarter, Q2 chances for a 'disappointment' is likely to be quiet high, but given the existing discounts in Utility stock prices, it might not amount to too much.

Summary

Utility stocks are experiencing an extended period of selling pressure, and negative price action attracts negative news items. However, Utilities have reached a point where they are now one of the more attractive sectors to be buying: yields are attractive, P/E ratios are competitive, and Buffett is a buyer. 

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Declan Fallon has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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