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The One Utility I'm Buying Today

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

I started off my quest to find the best utility company to invest in by wanting to find just one thing.  I wanted to know which one had the most power to generate a growing dividend -- that was an important first hurdle for me to overcome.

As I began my review I almost immediately tossed aside one company in particular because I didn’t think that they had the power to generate an increasing dividend for the foreseeable future.  However, as I continued looking into the sector I discovered that there was more to their capital expenses that needed to be understood.  The deeper I dug into it, the more I realized that this particular utility was just too cheap to ignore.   

That’s why I’ve decided to put aside my aspirations for a growing dividend and buy the utility that has the most potential to add both capital gains and substantial dividend income to my virtual “No Drip, No Mess” portfolio.  That utility is none other than Exelon (NYSE: EXC) and here’s why I think they’re a better choice than their power generating peers.

Because of all the digital ink I’ve already spilled on Exelon I’m going to keep this brief and focus on one metric that I think is the most important consideration for those buying today -- the current dividend yield vs. their peers.  If you’re interested in learning more about Exelon’s business please feel free to review the hyperlinks in the second paragraph for more of my thinking about their business and competitive position.

The following chart shows the wide disparity of dividend yields for a selection of some of the nation’s largest utilities:

<img src="http://media.ycharts.com/charts/091ad06b357fb04f01d1837263604615.png" />

EXC Dividend Yield data by YCharts

For a bit more context, each of those utilities has a market capitalization of more than $30 billion.  While each does serve a different market within the US, all serve more than a million customers and most have large merchant fleets.  While they all have their own nuances, they’re all fairly comparable when taken as a whole.  However, when taken together this chart shows a bit of divergence when using their dividend yield as a reference point.     

<table> <tbody> <tr> <td>Company</td> <td>Market Cap</td> <td> Current Share Price </td> <td> Annual Dividend </td> <td>Yield</td> <td>Price at Median Yield</td> <td>Percent Change</td> </tr> <tr> <td><strong><span>Dominion</span></strong><span> <span class="ticker" data-id="203276">(NYSE: <a href="http://caps.fool.com/Ticker/D.aspx">D</a>)</span></span></td> <td>$30.2 Bil</td> <td> $            52.71</td> <td> $         2.12</td> <td>4.02%</td> <td> $          45.71</td> <td>-13.29%</td> </tr> <tr> <td><strong>Duke</strong> <span><span class="ticker" data-id="203348">(NYSE: <a href="http://caps.fool.com/Ticker/DUK.aspx">DUK</a>)</span></span></td> <td>$45.1 Bil</td> <td> $            64.20</td> <td> $         3.08</td> <td>4.80%</td> <td> $          66.40</td> <td>3.43%</td> </tr> <tr> <td>Exelon</td> <td>$30.2 Bil</td> <td> $            35.30</td> <td> $         2.10</td> <td>5.95%</td> <td> $          48.72</td> <td>38.01%</td> </tr> <tr> <td><strong>NextEra</strong> <span><span class="ticker" data-id="224237">(NYSE: <a href="http://caps.fool.com/Ticker/NEE.aspx">NEE</a>)</span></span></td> <td>$29.0 Bil</td> <td> $            68.64</td> <td> $         2.40</td> <td>3.50%</td> <td> $          51.74</td> <td>-24.62%</td> </tr> <tr> <td><strong>Southern</strong> <span><span class="ticker" data-id="205529">(NYSE: <a href="http://caps.fool.com/Ticker/SO.aspx">SO</a>)</span></span></td> <td>$39.6 Bil</td> <td> $            45.47</td> <td> $         1.96</td> <td>4.31%</td> <td> $          42.26</td> <td>-7.07%</td> </tr> <tr> <td> </td> <td> </td> <td colspan="2"> Average Utility Yield = </td> <td>4.64%</td> <td> </td> <td> </td> </tr> </tbody> </table>

If you were to compare Exelon to this group their shares are undervalued by nearly 40% at the group’s median dividend yield.  This means that a growing dividend is unnecessary because much more value can be captured by capital appreciation if shares simply revert closer to the mean.     

The Trade

Even though I think Exelon is cheap, that doesn’t mean the market won’t offer it even cheaper.  That’s why in addition to buying a 1.5% allocation outright, I plan on writing an at-the-money January $35 put to fill out a full 5% allocation.  That’ll net me about $115 while I wait to add these shares to my portfolio.  The main reason I’m doing this is because the writing the put acts like a limit order and it will also generate more income than simply buying shares and collecting the dividend.  It’s also a strategy I can repeat and likely will all the way up to the $40 a share level that I think still represents a compelling value.

Risks and Bottom Line

Just because I think shares are cheap and could rise substantially from here doesn’t mean this is a riskless investment.  As the nation’s largest nuclear power generator they are just one incident from international spotlight.  While that’s a remote risk, the Fukushima disaster did remind us of its existence.

Further, Exelon just completed their merger with Constellation and if they run into integration problems that too could send shares even lower.  Finally, if the economy takes another turn for the worse it could have an effect on the electricity prices at their merchant fleet.  I think all of this and more are currently priced into shares which is why this is the one utility I’m buying today. 

latimerburned has an options position on Exelon. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Dominion Resources, Exelon, and Southern Company. 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. If you have questions about this post or the Fool’s blog network, click here for information.

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