Utilities: Reasonable Safety, Nice Dividends And Now Capital Gains?
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Utility stocks have long been considered a sound investment. They offer both consistent income and safety of principal. In return, they're expected to have limited capital gains potential.
However, the sector may be offering better opportunities for price appreciation than seen in the past. Utilities have not been immune to the volatility provided by the market's current trading-based mentality. While this volatility might pose discomforting share price drops to unprepared shareholders, it can also give alert investors the chance to buy in at bargain prices and capture meaningful capital gains.
A recent illustration was the sector sell-off in late 2012. Spurred by worries about tax policy changes on dividend income, selling momentum pushed the Utilities Select Sector SPDR ETF (NYSEMKT: XLU) down about 9% in just a few weeks. The severity of this decline may have unsettled long-term shareholders, but it also offered attractive entry points for those looking for stock market bargains. Shrewd buyers have booked a nice profit as the ETF recently matched last year’s peak.
Thanks to this kind of volatility, watching utilities can be productive. Most of the companies I follow deal in the transmission and distribution of either electricity or natural gas. Many of them also operate related businesses, such as coal mining for those who own coal-powered electric generation plants, or pipelines and storage for those in natural gas distribution.
While their profits are fairly consistent, utilities face some major risks that may sporadically upset results. The transmission and distribution business is highly regulated. Governmental agencies typically need to approve any change in what utilities can charge customers. That creates the risk of an occasional rate reduction directive or the formation of market conditions where rate increases are difficult. Another risk to utility profitability is the weather. Unusually warm winter temperatures and serious storm activity have resulted in erratic operating results at some companies.
Most utility stocks have bounced back from their late 2012 sell-off but there are still some that offer reasonable values and attractive dividends. Here are three I follow:
AGL Resources
AGL Resources (NYSE: GAS) is an Atlanta-based natural gas distributor. It's the nation’s largest natural gas-only utility based on customer count and serves approximately 4.5 million utility customers through seven states.
The company reported fourth quarter 2012 net income of $98 million, or $0.84 per share, compared to net income of $33 million, or $0.37 per share in 2011. Excluding merger-related expenses and some litigation charges, adjusted earnings were $0.91 a share for the fourth quarter of 2012 and $0.94 a share for 2011. The reduced per-share result was mainly attributed to historically warmer-than-normal weather and a higher number of shares outstanding in 2012 as a result of their Dec. 2011 merger with Nicor, Inc.
Despite the tepid fourth quarter, there are some positive signs. AGL has the potential of further expense reductions from the integration of Nicor, and there are some revenue growth opportunities in their utility rate base. But even without these benefits, the company's valuation, or expected average annual cash earnings multiplied by a market capitalization factor, looks reasonable.
AGL currently offers an approximate 4.7% dividend yield, and its fair intrinsic value looks to be around $41 per share based on estimated revenue of $3.9 billion, cash earnings of $433 million and an industry standard 11x multiplier.
Portland General Electric
Portland General Electric (NYSE: POR) is an electric utility that serves approximately 828,000 residential, commercial and industrial customers in the Portland/Salem metropolitan area of Oregon.
Portland General posted net income of $28 million, or $0.38 per share, for the fourth quarter of 2012 compared with $29 million, or $0.38 per share in 2011. The slight drop in net income was largely due to decreased residential energy deliveries from warmer weather during the heating season.
On the plus side, the company announced that construction of a new 220 megawatt generating plant would begin this year. This new facility should help the company maintain production levels and allow for some rate increases to recover expenditures. In fact, Portland General said they had recently filed a general rate case for a $105 million, or approximately 6%, overall increase in customer prices.
Portland General’s dividend yield is roughly 3.6%. With estimated revenues of $1.8 billion and cash earnings of $225 million, its reasonable business value looks to be around $32 per share using an 11x multiplier.
CenterPoint Energy
CenterPoint Energy (NYSE: CNP), headquartered in Texas, is a domestic energy delivery company that does electric transmission & distribution, natural gas distribution, and operates some interstate pipelines. The company serves more than 5 million customers.
CenterPoint reported net income of $134 million or $0.31 a share for the fourth quarter of 2012, compared to $117 million or $0.27 a share the previous year. Operating income for the fourth quarter of 2012 was $310 million versus $274 million dollars in 2011.
The company’s result highlighted a balanced energy delivery business portfolio. They received roughly 34% of 2012 revenues from the distribution of electricity, 55% from natural gas and 11% from its other businesses. The company said they are aiming for continued rate recoveries and expense management.
CenterPoint looks to have an intrinsic value of around $22 per share, assuming estimated revenues of $7.5 billion and cash earnings of $885 million with an 11x multiplier. They also have a dividend yield of about 3.9%.
Conclusion
Today’s momentum traders increasingly influence utility stock prices. While the volatility can be unnerving, it can also offer attractive discounts for the alert investor. The increased opportunity for capital gain, in addition to nice dividends and relative safety, probably makes the utilities sector worth watching.
Bob Chandler has a long position in AGL Resources, Portland General, and CenterPoint Energy. 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!
