3 Overvalued Utilities You Shouldn't Buy
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With the economy picking up and the possibility of dividend taxes more than doubling, utilities are becoming increasingly unattractive. Limited growth prospects and high multiples are just some of the most disconcerting signs. Below, I highlight stock by stock why I have this viewpoint.
Dominion (NYSE: D): A Stock To Avoid For Now
I have been a bear on this stock for some time now. For the year to date, it was more or less flat - underperforming the S&P 500 by around 1,500 bps. Despite this weakness, the stock is still comparatively elevated against the market, at a respective 22.5x and 15.7x past and forward earnings. While the company does offer a 3.9% dividend yield, this will become less appealing should the Obama administration successfully hike dividend taxes by 164%. And it's not like the company has stellar growth opportunities if it decides to reinvest the cash that would have otherwise been paid out to shareholders - analysts only forecast 5.7% annual EPS growth over the next 5 years.
The unregulated utilities business was relatively strong in the most recent quarter, as operating maintenance costs were cut by the equivalent of $0.08 per share. But hedges will roll off and earnings have been less that consistent; in fact, in the last 5 quarters management has only beaten expectations once. The company missed forecasts 2 times, and the other two were merely in-line, despite solid macro progress.
When you consider that the company has grown EPS by only 2.4% annually over the past 5 years and has a beta of 0.5, it is hardly unlikely that the company will somehow turn around and outperform fast-moving markets. Accordingly, I recommend holding out and backing higher-growth peers.
Compared to Dominion, NextEra and Exelon are relatively cheap. The former trades at 14x past earnings, versus 15.2x for Exelon. NextEra has beaten expectations in 4 of the last 5 quarters; Exelon has beaten expectations in only 3 of the last 5 quarters. This has led to NextEra outperforming Exelon by 1,600 bps with a return of 14.3%.
Results have been so weak overall that UBS recently downgraded Exelon to a "sell" from "neutral." Part of the rationale included weakened power prices and margin compression. The company's 5.7% dividend yield will also come under pressure from weak growth prospects. Over the next 5 years, analysts forecast EPS to decline by 2.7% annually. With a beta of 0.5, I also would not expect the tide to drastically change in Exelon's favor.
I further expect NextEra and Exelon to suffer from rising natural gas prices. Consolidation efforts for both producers have also forced them to make concessions to regulators that will limit the amount of subsequent value accretion. I am also very skeptical about NextEra's position in renewable energy. As the largest producer of domestic wind energy, it is exposed to cheaper and more consistent alternatives. As one analyst correctly recalls, "wherever wind development was put in place, natural gas demand went up." Accordingly, I recommend keeping out.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Dominion Resources, Exelon, and 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.If you have questions about this post or the Fool’s blog network, click here for information.