These 4 Numbers Prove Who Is The Best In This Industry
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Today’s low interest rate environment is causing some stocks to rise because they offer investors a superior yield to what they can get elsewhere. If there is one sector of the market that worries me, it’s the utilities industry. Investors seem to have forgotten that utilities usually act like interest rate cyclicals, and when interest rates inevitably rise, these stocks could take a beating. That being said, many investors still like the stability and predictability of the industry, and if you are going to pick a stock in this industry, you might as well pick the best one, right? In my eyes the best utility stock today is Southern Co (NYSE: SO).
Risk Versus Reward
The biggest risk facing utility stocks is interest rate risk as I mentioned. However, investors should be aware that other risks face utility stocks as well. The rise of energy awareness threatens to cut consumption, which is critical to a utility’s growth. Consumers and businesses alike are more aware of energy efficiency, and building systems, appliances, computers, and other items are all becoming more energy efficient.
A secondary risk to these utilities is connected to interest rates as well. Most utilities use long-term debt to fund their projects, and unlike consumer debt that may be locked in at a fixed rate for many years, corporate debt is rarely locked in for an extended amount of time. As rates rise, this corporate debt will be re-priced, and the company’s cost of operations will increase.
The point is, investors buying utility stocks today need to be aware that the yield they receive from these companies today isn’t enough of a reason by itself to invest.
If You Are Willing To Take The Risk, Invest In The Best
For investors who plan on holding a utility stock for a while, reinvesting the dividends, and hoping for the best, I would suggest Southern Co. To be fair, it’s not that Southern Co’s peers aren’t worthy of investigation, it’s just that Southern Co. does so many things better.
Companies that are usually mentioned in Southern Co’s peer group would be names like Duke Energy (NYSE: DUK), Exelon (NYSE: EXC), and Consolidated Edison (NYSE: ED). Each of these companies is a large utility that dominates their respective markets. That being said, the first reason I consider Southern Co the best is the most obvious, they have the highest yield.
Most investors are buying utility stocks for yield, so why not start with the highest payout of their peer group? At current prices, Southern Co’s yield is about 4.65%, which is just slightly higher than Duke at 4.57%, Consolidated Edison at 4.35%, or Exelon at about 4%. The highest yield doesn’t guarantee investors a winner, but in this case it just so happens that the best company also pays the most.
The second reason to consider Southern Co is the company is expected to grow earnings faster than their peers over the next few years. The average analyst expects the company to report EPS growth of just under 5%. By comparison, Duke is expected to grow earnings by about 4%, Consolidated Edison is expected to grow by about 2.3%, and Exelon is actually expected to show an earnings decline of about 3.4%.
I don’t like to assume that analysts are correct about future growth rates, so I always try to check current earnings to see if their assertions make sense. One way to measure the organic growth of any utility is by their revenue growth. In the current quarter, Southern Co reported an 8.1% increase in revenue. The only one of their peers to report better revenue growth was Exelon, but that had more to do with Exelon’s prior year quarter being so bad, rather than organic growth. If you look at Duke’s negative growth, or Consolidated Edison’s 3.44% revenue growth, you can see that Southern Co is the best of the bunch.
Last but not least, Southern Co is growing their cash flow as well. In fact, if you look at what I call core operating cash flow (net income + depreciation), Southern Co is growing faster than any of their peers. On a year-over-year basis, the company grew operating cash flow by 33.7%. The only company to come close to this performance was Duke, with a 24.11% increase, but keep in mind Duke had the benefit of the Progress Energy merger. Exelon’s operating cash flow grew by about 4.3%, and Consolidated Edison actually saw a decline of 13.65%.
Buy The Best, Forget The Rest
As you can see, whether we look at dividend yield, earnings growth, revenue growth, or cash flow growth, Southern Co tops them all. Investors looking for a good yield with reasonable growth should look no further. I’m not suggesting there isn’t risk in buying Southern Co at these levels. It’s possible that higher interest rates would make the stock less attractive.
For investors that want exposure to the utilities industry, this should be very simple. Southern Co should be the first company on your watch list, everyone else should come in second. After all, that seems to be the theme, Southern Co is the best so just forget the rest.
Chad Henage has no position in any stocks mentioned. The Motley Fool recommends 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!