Highly Rated Utilities 20% Cheaper Than Before

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

On a regular basis I use the CAPS Screener on Fool.com to come up with new investment ideas. One thing I constantly look for is companies that are selling for a price at least 20% below their 52 week highs. While there is no guarantee that these stocks are a bargain, it certainly helps to know that I can pay 20% less than other investors. If I find a stock I like that is also at least 20% below its 52 week high, I put it at the top of my Watchlist. I recently ran a screen for companies in the utilities industry that are selling for this 20% discount. There were three companies that caught my eye and seemed to warrant further investigation.

Exelon (NYSE: EXC):

Exelon is a company that I have owned in the past. I like the idea of investing where my money is spent, and every time I pay my BG&E utility bill, Exelon is the company that benefits. The company operates utilities that serve the Illinois, Pennsylvania, and Maryland areas. The first thing that most investors might notice about Exelon is the company's mouth watering dividend. At current prices the yield is north of 7.1%, and if sustainable would represent one of the more attractive dividends in the market, in my opinion. There is just one problem: In the company's last earnings call they suggested that the dividend policy would have to be revisited if pricing didn't recover the way they expected.

The company's number one priority is to maintain their investment grade debt rating, and their second priority is the dividend. This sounds very similar to what General Electric said a few years ago right before they were forced to cut their own payout. In addition, Exelon's payout ratio has recently gotten out of hand. As a result of the company's operating cash flow dropping 20% over the last three years, the free cash flow payout ratio has risen significantly. In the last three years, the payout ratio averaged about 75%, but last year it jumped all the way up to 172%. While the current quarter was better, the payout ratio still was north of 90%. In addition, analysts are calling for earnings contraction over the next few years, and the company has taken on $6 billion in new long-term debt in the last four quarters. I'm afraid this stock is selling for a 20% discount for good reason. Until the company resolves the uncertainty around the dividend I would stay away.

CPFL Energia S.A. (NYSE: CPL):

CPFL is a Brazilian utility, and according to Wikipedia, Brazil is the tenth largest energy consumer in the world. As “one of the fastest growing economies in the world,” Brazil offers investors utilities that should grow faster than their domestic counterparts. Analysts are expecting CPFL to grow earnings by about 6.6% over the next few years, and the company needs to meet these expectations to change the direction of its operations in the last few years. Over the last three years, operating cash flow was basically flat, but the company grew its capital expenditures by over 40% in the same time frame. While part of this has to do with multiple acquisitions, the company's balance sheet has been weakened by these purchases as well. In fact, in just the last year CPFL has seen its cash balance drop by $134 million while long-term debt has increased by over 80%. That being said, CPFL's dividend is the attraction at the current time, sporting a yield of over 7.6% on a trailing basis. If CPFL can realize cost savings and increase its growth rate from these acquisitions, this could be a good stock for income hungry investors.

Energy Company of Minas Gerias (NYSE: CIG)

Though this company sounds like the power company for a city in The Lord Of The Rings, it's actually a Brazilian utility as well. Given that we know Brazil is a fast growing economy, it makes sense that there could be multiple opportunities in this sector. However, there are several huge differences between Energy Company of Minas Gerias and CPFL. First, CIG has a lower yield at about 5.27%, but the company only paid out 33.67% of its free cash flow versus an over 70% payout ratio at CPFL. Second, CIG has grown operating cash flow slightly at 2.61% in the last three years versus flat growth at CPFL. The two biggest differences between the companies have to do with their balance sheets. While CPFL has seen its balance sheet weaken significantly, CIG has decreased long-term debt by over 40% in the last four quarters. In addition, CIG sells for a seemingly cheap forward P/E ratio of just 4.94. However, there is one problem, analysts are calling for EPS contraction over the next few years to the tune of 4.6%. If CIG can prove analysts wrong, the company's low payout ratio and respectable dividend could be an attractive way to play Brazil's growing economy.

Conclusion

As we have seen, there is a big difference between the above three companies. While Exelon might be able to keep its dividend and this would be an amazing entry point, I wouldn't take that bet. CPFL has a similarly high dividend, but comes with risks of its own. The company's acquisitions have hurt their balance sheet, and whether their dividend can be maintained will likely come down to realizing efficiencies from these purchases. CIG offers its own set of challenges, but looks like potentially the best 20%-off play. The company's main problem is small earnings contraction expected in the next few years. However, the company has improved its balance sheet significantly and pays a nice yield. Though Exelon and CPFL have higher yields, these yields might not be sustainable. Use the above information as a starting point for your own research to see if this 20%-off sale represents a good entry point, or if these stocks deserve their holiday markdown.


MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Exelon. 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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