Screening For Top-Rated Utilities

By Chad Henage - May 10, 2012 | Tickers: NWE, TE, UNS | 0 Comments

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I recently used the Motley Fool CAPS Screener to come up with some new investment ideas. The screen I ran was pretty simple, I wanted at least a 2% yield, 10% or better EPS growth in the last 3 years, and the stock had to be rated 4 or 5 stars by the CAPS community. Looking at the utilities industry, there were 3 that had a yield of over 4% that looked like they could be attractive. The names I came up with were TECO Energy (NYSE: TE), UniSource Energy (NYSE: UNS), and Northwestern Corp (NYSE: NWE). Since most investors only buy one or two companies to represent an industry, let's find out which of these 3 looks like the best buy. 

On the basis of PEG ratios, Northwestern looks like the best deal. The company scores in the middle of the three when it comes to P/E and growth, but the comparison of the two numbers is a bit better than UniSource. There are other factors to consider, but for now we'll give this category to Northwestern. (TECO – 1, UniSource – 2, Northwestern – 3)

Since most investors are buying utilities for their yield, we need to compare how these three are doing in that area. TECO has the highest current yield at 4.96%. TECO also has the lowest free cash flow payout ratio, at 61.27% of last year's free cash flow. UniSource Energy comes in second at 4.79%, then Northwestern at 4.27%. The biggest difference between the three is, while TECO has an acceptable payout ratio, the other two have negative payout ratios. In fact, even taking a three year average, you still get a negative payout ratio for UniSource. With the best yield, and the best coverage, TECO wins this category hands down. (TECO – 3, UniSource – 2, Northwestern – 1)

A second reason to own a dividend paying stock is for dividend growth. There are many investors that actually consider dividend growth more important than current yield. On this score, UniSource beats the other two companies handily. However, there is a caveat. UniSource shows a 5 year dividend growth rate of 15.75%. Northwestern shows 2.7%, and TECO shows 2.11%. The caveat is UniSource owes most of this growth to increases from more than the last 2 years. In the last two years, UniSource has raised its dividend by 7.6%, then by 2.3% respectively. I would expect that going forward UniSource will be much more conservative in its dividend growth, with the 2.3% increase being more the norm. With this in mind, we'll give the category to UniSource, but investors should keep this dramatic deceleration in the dividend in mind. (TECO – 1, UniSource – 3, Northwestern – 2)

One way to compare the strength of a company versus another is to compare their cash flow statements. I use a metric called free cash flow per $1 of assets. It evens the playing field, and allows me to compare companies that are different sizes in an apples-to-apples comparison. Look at how these three stack up using this measurement:

Clearly UniSource has had problems in the last year. The primary reason UniSource had negative free cash flow, was adjustments for the value of certain balance sheet items such as accounts payable, and fuel assets. TECO easily outproduces the other two when it comes to free cash flow. With 4 times the cash flow of its nearest competitor, TECO is our clear winner. (TECO – 3, UniSource – 2, Northwestern – 1)

Last but not least, let's compare the balance sheets of each company. I use the debt-to-equity ratio to get an idea of the relative leverage each company has. Northwestern has the least amount of leverage with a ratio of 1.09 and TECO comes in second at 1.18. UniSource has nearly double the leverage of the other two with a ratio of 2.10. With less leverage comes less risk and more flexibility, which gives Northwestern the edge. (TECO – 2, UniSource – 1, Northwestern – 3)

Add it all up and we find that TECO scores a 10, UniSource scores a 10, and Northwestern comes in at 10. A tie? Not really, when it comes to utilities, there is one factor that is more important than the others. That is the ability to pay the dividend and increase it. While the other two companies have positive traits, TECO appears to have the best mix of numbers. TECO pays the highest dividend, has the lowest free cash flow payout ratio, and generates the most free cash flow with its assets. While its record of dividend increases isn't quite as good, and its balance sheet is slightly weaker, the company doesn't miss those categories by much. While our score is a tie, I'll take the highest yield and best cash flow as the tiebreaker every time.

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