Not Just The Same Old Utilities

12/26/2011


You might think that utilities are slow-growth, high-yield, defensive stocks. And you'd be right. Most of the time.

Still, investors who assume all utilities are similar risk making poor investment decisions. As the table below shows, utility industry groups have substantially different characteristics. Traditional electric, gas, and diversified utilities tend to deliver high dividend yields. However, even within those groups you'll find a few stocks that break the mold. Three of the 32 electric-utility stocks in our 80-stock Utility Update yield less than 3%. Several others are expected to deliver profit growth in the high-single-digits this year and next year, well above the average for the group.

UTILITY INDUSTRY ANALYSIS
As a group, utility stocks average a 17% premium to their three-year median P/E ratios. Energy/utility hybrids boast the strongest growth potential, while electric and diversified utilities pay the highest yields. For additional stats on both individual utilities and industry averages, see our Utility Update supplement.
------- Total Return -------
----- P/E Ratio -----
12-Month
----- Growth -----

Est. EPS
----- Growth -----

Utility Industry (No. Of Cos.)
Div.
Yield
(%)
Payout
Ratio
(%)
3
Mos.
(%)
6
Mos.
(%)
12
Mos.
(%)
Trailing
Vs. 3-Yr.
Median
Sales
(%)
Oper.
EPS
(%)
Curr.
Year
(%)
Next
Year
(%)
Diversified (23)
3.9
58
5
7
18
16
1.09
4
9
4
8
Electric (32)
4.0
60
5
8
18
16
1.11
4
2
1
5
Energy/Util. Hybrids (4)
2.1
40
1
(3)
9
18
0.95
7
17
11
11
Independent Power (3)
0.8
13
(24)
(25)
(6)
18
2.30
(10)
(25)
(28)
2
Natural Gas (11)
3.6
64
7
11
17
18
1.17
(2)
(2)
(2)
7
Water (7)
3.4
70
8
4
2
20
0.98
7
7
(3)
13
Utility Update (80)
3.6
58
5
6
15
17
1.17
3
4
1
7
Notes: Averages exclude payout ratios, returns, and growth rates of 100% or more and P/E ratios below 0 or above 75.

Energy/utility hybrids, or companies that operate both regulated utilities and large energy-production businesses, have the potential for substantially higher profit growth than the average utility but don't pay as a high a yield. Independent power producers have the potential for explosive growth but have underperformed in recent months, hurt by weak demand and low prices for power.

Our Top 15 Utilities portfolio features mostly electric and diversified utilities — which make up 69% of the 80 stocks in our Utility Update and nearly 90% of their combined stock-market value — but also includes one hybrid, one gas utility, and one water utility. Many of the diversified utilities operate substantial nonregulated businesses, giving investors who mimic the Top 15 Utilities portfolio broad exposure to the sector.

This week, we are making a switch to the Top 15 Utilities portfolio, which consists entirely of stocks that earn A ratings in our Utility Update supplement. Electricity provider NextEra Energy's ($59; NEE) operating momentum has evaporated, with sales and profits down in three of the last four quarters. Couple the momentum issues with an unattractive valuation and a marked decline in Quadrix® scores, and it's time to get out of NextEra. In its place, we are adding American States Water ($35; AWR), among the stocks reviewed below.

We advise readers seeking utility exposure to purchase equal-dollar amounts of each stock in the Top 15 Utilities portfolio, which currently yields 3.9%, versus the average of 3.6% for stocks in our Utility Update. Since the start of 2007, the Top 15 Utilities portfolio has returned 36.2%, versus 19.2% for its benchmark, the S&P 1500 Utility Sector Index. In the following paragraphs, we review three members of the Top 15 portfolio, each from a different industry.

Diversified

Sempra Energy ($53; SRE) has delivered impressive growth in the nine months ended September, with sales up 12% and per-share operating earnings up more than 13%. Sempra provides natural gas to 6.6 million customers and electricity to 1.4 million customers in Southern California but also has a substantial presence in businesses with greater growth opportunities.

Sempra generates nearly one-fourth of its revenue from power-generation and energy operations. Wall Street expects per-share-profit growth of 3% in 2012, a target that sounds conservative. At just 12 times trailing earnings, 23% below the industry median, Sempra offers growth potential greater than that of most utilities for a bargain price.

Hybrid

With a negative total return of 13% over the last six months, Energen ($48; EGN) has dragged on the Top 15 Utilities portfolio. Energy stocks as a whole have performed poorly, and energy production accounted for about two-thirds of Energen's revenue in the 12 months ended September. However, while energy has weighed on Energen recently, historically it has boosted performance. Over the last 10 years, Energen managed an annualized total return of nearly 18%, more than double the average for the stocks in our Utility Update.

The energy component serves as both a diversification tool and, over the long haul, a growth kicker for the Top 15 portfolio. Energen is aggressively drilling wells, and it seems capable of topping consensus profit targets, which call for a decline of 2% in 2012 and annualized growth of 4% over the next five years.

Water

American States Water ($35; AWR) provides water to more than 250,000 customers in Southern California and also operates a much smaller electric utility. American States' Quadrix Overall score of 88 is the highest in the sector, and the stock also earns at least 98 in both of our sector-specific scores designed to rank utilities versus other utilities.

The company has delivered 10 consecutive years of higher sales. In the last four quarters, American States delivered 13% growth in both sales and per-share operating earnings, while per-share operating cash flow jumped 33%. Despite that growth, expectations are modest. Wall Street projects roughly flat profits in 2012. At 16 times trailing earnings, American States trades roughly in line with the average utility but at least 19% below its peer-group median and its three- and five-year average P/E ratios.

TOP 15 UTILITIES PORTFOLIO
Components of our Top 15 Utilities portfolio average lower valuations and higher Quadrix scores than the typical utility. They also deliver slightly higher yields, yet pay out less of their earnings in dividends.
---- Total Return ----
--- P/E Ratio ---
Quadrix
----- Score -----
Sector-Specific
----- Scores -----
Company (Price; Ticker)
Div.
($)
Div.
Yield
(%)
Payout
Ratio
(%)
3
Mos.
(%)
6
Mos.
(%)
12
Mos.
(%)
Trailing
Vs.
3-Yr.
Median
Value
Overall
12-
Factor
Sector
Reranked
Overall
Industry
Alliant Energy
($43; LNT)
1.70
4.0
61
8
9
22
15
1.11
43
49
36
63
Electric
American Elec. Pwr.
($40; AEP)
1.88
4.7
61
6
8
17
13
1.13
63
46
78
83
Electric
American States
Water ($35; AWR)
1.12
3.2
50
5
5
2
16
0.75
60
88
98
99
Water
Cleco ($37; CNL)
1.25
3.4
52
6
8
24
15
1.10
52
84
95
98
Electric
CMS Energy
($21; CMS)
0.84
3.9
56
5
10
16
14
1.02
52
49
40
58
Divers.
Duke Energy
($21; DUK)
1.00
4.7
70
10
17
27
15
1.13
45
55
83
88
Electric
El Paso Electric
($34; EE)
0.88
2.6
35
7
13
23
14
1.12
47
77
88
93
Electric
Energen ($48; EGN)
0.54
1.1
12
7
(13)
4
11
0.94
71
67
99
94
Hybrid
Entergy ($72; ETR)
3.32
4.6
42
10
6
7
9
0.82
78
64
91
95
Electric
Exelon ($42; EXC)
2.10
5.0
49
(3)
4
8
10
0.92
60
66
85
89
Divers.
Laclede Group
($40; LG)
1.66
4.1
59
6
11
14
14
1.06
50
50
65
81
Gas
PPL ($29; PPL)
1.40
4.9
49
(1)
7
15
10
0.70
71
84
100
100
Divers.
Public Service Ent.
($31; PEG)
1.37
4.4
48
(9)
1
4
11
1.05
66
47
94
84
Divers.
Sempra Energy
($53; SRE)
1.92
3.6
44
2
3
6
12
1.02
65
68
96
96
Divers.
UniSource Energy
($37; UNS)
1.68
4.5
63
(1)
2
7
14
0.79
60
49
64
70
Electric
Portfolio Average
3.9
50
4
6
13
13
0.98
59
63
81
86
Note: Quadrix scores are percentile ranks, with 100 the best.

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