Top Picks In 4 Utility Industries

3/25/2013


The S&P 1500 Utility Sector Index has delivered a total return of 12.8% over the last year, just below the broader S&P 1500 Index's 13.6%. And over the last five years, utilities returned an annualized 5.4%, matching the broad index.

While those returns suggest the sector is fully participating in the bull market, they obscure plenty of details. For example:

• Over the last year, the water utility industry returned 37.1%, versus just 4.8% for independent power producers.

• Over the last five years, diversified, natural-gas, and water utilities delivered returns higher than those of the entire sector, while electric utilities and power generators lagged.

• While utilities as a whole earn mediocre Quadrix scores, electric utilities average higher Value (61) and Overall (50) scores than any other industry in the sector.

The differences between industries are neither stark nor consistent enough to warrant investors' focus on a particular group, though we are finding most of the better values among diversified and electric utilities. Also, the numbers illustrate the importance of diversification within the sector.

TOP 15 UTILITIES
Company (Price; Ticker)
Yield
(%)
Industry
American States Water ($56; AWR)
2.5
Water
CMS Energy ($27; CMS)
3.8
Divers.
Idacorp ($47; IDA)
3.2
Electric
NextEra Energy ($75; NEE)
3.5
Electric
NV Energy ($20; NVE)
3.8
Electric
OGE Energy ($67; OGE)
2.5
Divers.
Plains All American ($54; PAA)
4.2
Svcs.
Public Service Ent. ($33; PEG)
4.3
Divers.
PNM Resources ($23; PNM)
2.9
Divers.
PPL Corp ($30; PPL)
4.9
Divers.
South Jersey Industries ($55; SJI)
3.2
Gas
Sunoco Logistics ($62; SXL)
3.5
Svcs.
UGI ($37; UGI)
2.9
Divers.
Wisconsin Energy ($41; WEC)
3.3
Divers.
Westar Energy ($32; WR)
4.2
Electric

Our Top 15 Utilities portfolio (presented above and in greater detail at www.DowTheory.com/Go/Top15) contains a diversified mix of utilities and a couple pipeline operators. Below are top picks from the four utility industries represented in the portfolio:

Diversified

UGI ($37; UGI) earns a Quadrix Overall score of 81, one of just four stocks in our Utility Update to score above 80. UGI also scores at least 96 in both of our sector-specific scores. UGI distributes natural gas and electricity, generates electricity, and transports and stores gas. However, its largest operation is propane. U.S. and international propane operations account for 75% of revenue and 54% of operating profit. 

Electric

The consensus projects conservative profit targets for NV Energy ($20; NVE) — a decline of 2% this year and a gain of 4% next year. But analyst estimates are on the rise. NV Energy, which provides electricity to more than 2 million customers in Nevada, raised its dividend 12% last month and now yields 3.8%. Over the last five years, NV Energy's dividend has risen at an annualized rate of 19%.

Natural gas

South Jersey Industries ($55; SJI) is the newest member of the Top 15 Utilities portfolio, added last month. The company's natural-gas utility in New Jersey accounted for 63% of operating income last year. South Jersey also operates units in energy marketing, oil and gas exploration, and heating-system installation. The consensus projects per-share-profit growth of 10% this year and 6% next year, unusually high for a utility.

Water

American States Water ($56; AWR) has grown sales in each of the last 10 years, a feat managed by only three companies in our Utility Update — all water utilities. Over the last year, sales rose 11%, per-share profits 26%, and operating cash flow 27%. The consensus projects a 2% decline in per-share profits over the next two years, but analysts tend to underestimate American States — profits have topped the consensus by an average of 32% in the last four quarters.


Utilities versus MLPs

Investors who covet the yield of utility stocks may be drawn to master limited partnerships (MLPs), which also tend to generate solid income.

With so many utilities operating natural-gas pipelines or storage businesses, the line between utilities and MLPs can get blurry. EQT Midstream Partners ($39; EQM), a natural-gas transmission and storage partnership, is a subsidiary of EQT ($67; EQT), which owns both a natural-gas utility and production assets. Questar ($24; STR), another utility/energy hybrid, spun off some of its energy-related businesses as QEP Resources ($32; QEP) in 2010, and QEP in turn plans to create an MLP in the June quarter.

Even "traditional" utilities are getting into the act, drawn to MLPs as a financing vehicle.

After months of talk about spinning off its midstream assets into an MLP, CenterPoint Energy ($23; CNP) announced a joint venture with Top 15 Utilities portfolio component OGE Energy ($67; OGE) and ArcLight Capital Partners to create an MLP with nearly $11 billion in assets.

Given the increase in U.S. energy production and long-run demand, well-run pipeline and storage businesses should enjoy plenty of growth opportunities.

Dominion Resources ($57; D) already has at least one joint venture that operates like an MLP. During the company's conference call for December-quarter earnings, the CEO talked around the topic so much that he eventually had to say, "We're not announcing today that we're going to do an MLP, okay?" Utilities such as National Fuel Gas ($60; NFG), NiSource ($28; NI), and Sempra Energy ($79; SRE) have also been mentioned in connection with MLPs, though the companies haven't announced anything.

The Alerian MLP Index has more than doubled the total return of the S&P 1500 Utility Sector Index over the last decade. But here are three things you should know before buying:

• MLPs don't pay taxes at the corporate level. This allows them to pay rich dividends, but it also complicates investors' taxes. Some distributions are taxed at ordinary-income rates, and some are treated as a return of principal, lowering the security's cost basis. MLP investors will receive a K-1 form.

• To qualify for their tax break, MLPs must generate 90% of cash flows from "qualifying sources" such as energy production or transportation. Utility operations don't qualify for MLP treatment; if you see an MLP with a name similar to that of a utility, it may be related, but you're not buying a piece of the regulated utility. Most MLPs operate in riskier businesses than regulated utilities. 

• The Forecasts doesn't recommend any MLPs on its buy lists. However, our Top 15 Utilities Portfolio contains two — Plains All American Pipeline ($54; PAA) and Sunoco Logistics Partners ($62; SXL). For a list of MLPs we rank, visit
www.DowTheory.com/Go/Alt.

 


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