Utilities Pricey After Run-Up

3/28/2016


Instability in emerging markets and sluggish economic growth in the U.S. have caused investors — and the Federal Reserve — to lower their expectations for the pace of the Fed's interest-rate hikes. The perceived safety of low-volatility stocks with big dividends, such as utilities, has become an attractive refuge. But the price of admission has become increasingly expensive.

Utilities are averaging a return of 13% including dividends so far this year, while the broader S&P 1500 Index has gained just 2%. None of the other nine sectors has generated more than a 10% average total return.

S&P 1500 utility stocks tend to serve up either a feast or a famine. In each of the past 12 years, their annual total returns have ranked in either the top three or bottom three of the index's 10 sectors. If the rest of 2016 mimicks its first few months, S&P 1500 utilities will become the index's top-returning sector for the third time in six years. 

Despite the rally, income-minded investors can still find a solid dividend yield, with utilities averaging 3.2%. But the sector's average Quadrix Value score has plunged to 46 — 33% below its average Value rank of 69 since December 1994. No other sector looks so expensive relative to historical norms in Quadrix.

We monitor 77 utilities, while the S&P 1500 Index contains 61 utilities. Strength among our monitored utilities has been widespread, with all but three delivering positive returns so far in 2016. All six of our utility industries, shown in the below, averaged year-to-date total returns in excess of 10%.

MONITORED UTILITIES
All six utility industries have produced average total returns of at least 7% in 2016. Although most utilities have struggled to generate operational growth in the past 12 months, their year-ahead prospects generally look more favorable, especially for the natural-gas industry. All numbers other than company count are averages.
Total Return
Dividend
12-Month
---- Change ----
Est. EPS
Change.
Next 12
Months
(%)
----- P/E Ratio -----
-------- Quadrix Scores --------
Industry
(Number Of Companies)
YTD
(%)
1
Year
(%)
Yield
(%)
5-Year
Annual.
Growth
(%)
EPS
(%)
Sales
(%)
Trailing
Forward
Momen-
tum
Value
Overall
Diversified (17)
15
11
3.6
4
0
(5)
6
19
18
47
50
53
Electric (30)
12
15
3.3
4
(3)
(2)
8
20
19
48
47
49
Independent (3)
7
(25)
2.5
(1)
NM
(7)
(40)
21
40
38
56
52
Hybrid (2)
18
(25)
5.9
12
(12)
(30)
11
19
17
27
60
42
Natural gas (17)
14
20
4.4
4
(4)
(14)
15
23
21
49
44
50
Water (8)
10
16
2.5
5
(2)
2
6
23
23
58
32
53
Monitored utility
average (77)
13
13
3.6
4
(3)
(6)
8
21
20
48
46
51
Note: Quadrix scores are percentile ranks, with 100 the best.     NM Not meaningful because of operating losses. 

Stocks in both the natural-gas and water industries averaged total returns above 19% over the past 12 months. Although the rally has stretched their valuations, both industries enjoy relatively solid operating momentum. Looking ahead, natural-gas stocks are projected to average a leading 15% growth in per-share profits over the next 12 months.

We prefer to invest on a stock-by-stock basis rather than placing industry bets. Still, the diversified and natural-gas industries make up two-thirds of our Top 15 Utilities portfolio.

In the Top 15 Utilities, UGI ($40; UGI) replaces WGL ($70; WGL) this week. Four more top picks from the portfolio are reviewed as well.

UGI operates a traditional utility business and holds a 26% stake in AmeriGas Partners ($43; APU), a retail propane distributor. In May, UGI expanded its presence overseas by acquiring Totalgaz, a France-based distributor of liquefied petroleum gas, in a deal worth $497 million net of cash. UGI's per-share profits are projected to rise 8% in the 12 months ending December. The stock trades at 18 times estimated year-ahead earnings, below the average of 21 for natural-gas utilities in our Utility Update.

The stock earns an Overall rank of 85, and both sector-specific scores exceed 90. Although its dividend yield of 2.3% lags the other stocks in our Top 15 Utilities, UGI has grown its dividend at an annualized rate of 8% over the past five years — third-highest among the stocks in the portfolio. Its payout ratio of 48% is low by sector norms, suggesting UGI is capable of maintaining its generous dividend growth in the future. Like other Top 15 Utilities stocks UGI earns an A (above average) rating on our Utility Updateand on our Monitored List.


WGL ranks among our portfolio's biggest winners, its shares surging 30% since we added the stock last February, versus the 8% gain for the S&P 1500 Utility Sector Index. But that rally leaves the stock looking stretched. WGL earns a Quadrix Value rank of just 32, dragging down its Overall score to 39. Given WGL's meager prospects for profit growth, the stock does not merit its elevated valuation. WGL should be sold.


Allete ($57; ALE) is more diversified than most companies in the electric-utilities industry. It operates regulated electric utilities based in Wisconsin and Minnesota (67% of 2015 revenue), as well as a renewable-energy unit that focuses on wind-energy projects (18%), plus coal mines in North Dakota and real estate investments in Florida (combining for 7%).

In February 2015, Allete acquired a water-management company (8%). That deal, combined with Allete's growth in renewable energy, drove total revenue 31% higher last year. No other utility we monitor grew sales as quickly.

The stock has returned 14% including dividends so far in 2016, yet trades at a reasonable 17 times trailing earnings — 5% below its three-year average and 16% below the average for electric utilities we monitor. Yielding 3.6%, Allete scores above 90 for both sector-specific ranks.


CMS Energy ($42; CMS) runs an electric utility (67% of 2015 sales) and a natural-gas utility (30%), while also operating as an independent power producer (3%). Per-share profits climbed 7% in 2015, as rate hikes more than offset lower demand for natural gas due to warmer winter weather last year. CMS operates primarily in Michigan.

The stock has delivered a total return of 20% over the past 12 months, nearly twice the return of the average diversified utility we monitor. That rally has dragged CMS' Value rank down to 38 from 58 a year ago. At 22 times trailing earnings, the stock trades near its highest level since 2008 and 17% above its industry average. That premium seems warranted, given the company's improving growth prospects.

CMS projects 5% to 7% higher earnings per share this year and 6% to 8% annually starting in 2017. CMS also raised its dividend 7% to $0.31 per share in January, marking its ninth dividend hike of more than 5% in as many years.


Spectra Energy Partners ($48; SEP) enjoys a dividend yield of 5.3% — highest among the stocks in our Top 15 Utilities portfolio. It has raised its per-share dividend every quarter since inception — 33 quarters in all — anywhere from $0.005 to $0.03. A master limited partnership (MLP), Spectra operates a network of oil and natural-gas-liquids pipelines and natural-gas storage facilities. Like many MLPs, Spectra avoids direct exposure to commodity prices because its business relies on long-term contracts. Spectra says its existing U.S. pipeline contracts have nine years remaining, on average.

The stock scores above 75 for five of six Quadrix categories, contributing to an Overall rank of 93. Spectra's per-share profits jumped 20% last year on 8% revenue growth. Although growth will likely prove more challenging in 2016, analyst profit estimates have steadily risen in the past 90 days.


Star Gas Partners ($8; SGU) is the largest U.S. retail distributor of home heating oil, taking a 5.5% share of the market in fiscal 2015 ended September. The company also distributes propane and installs heating and air-conditioning systems. Star Gas, a master limited partnership (MLP), earns an Overall score of 89.

With a market value of $455 million, Star Gas is the smallest member of our Top 15 Utilities portfolio but offers an outsized dividend yield of 4.8%. Star Gas has hiked its dividend at least 6% in each of the past three years; dividend increases are typically announced in the second half of April. Favorable cash-flow trends — both operating cash flow and free cash flow are up in five of the past six quarters — should support future dividend growth.

TOP 15 UTILITIES
Total Return
12-Month Chg.
Est. EPS
Change,
Next 12
Months
(%)
---- P/E Ratio ----
------- Quadrix Scores -------
Company (Price; Ticker)
Div.
Yield
(%)
YTD
(%)
1
Year
(%)
EPS
(%)
Sales
(%)
Trailing
Forward
Momen-
tum
Value
Overall
Industry
Allete ($57; ALE)
3.6
14
11
16
31
(5)
17
17
78
65
77
Electric
Atmos Energy ($72; ATO)
2.3
15
33
4
(23)
7
23
21
64
32
60
Natural gas
Avista ($40; AVA)
3.5
(14)
(21)
(3)
1
11
21
19
55
43
55
Diversified
CMS Energy ($42; CMS)
3.0
16
20
7
(10)
7
22
20
71
38
67
Diversified
EQT Midstream ($71; EQM)
4.0
(4)
(4)
35
29
2
14
15
86
67
96
Services
Laclede Group ($66; LG)
3.0
12
32
2
(1)
9
21
19
42
38
39
Natural gas
NextEra Energy ($118; NEE)
3.0
14
15
9
3
1
21
19
27
45
54
Electric
NiSource ($23; NI)
2.7
19
43
(5)
(12)
40
16
21
39
44
38
Natural gas
Portland General ($40; POR)
3.0
9
10
(7)
0
9
19
18
35
53
39
Electric
Public Service Enterpr. ($46; PEG)
3.5
21
13
10
(4)
(13)
16
16
34
61
63
Diversified
Scana ($68; SCG)
3.4
14
27
1
(12)
5
19
17
37
46
50
Diversified
Spectra Energy ($48; SEP)
5.3
2
(6)
20
8
1
13
14
76
57
93
Services
Star Gas Partners ($8; SGU)
4.8
8
16
147
(23)
NA
8
 NA 
42
94
89
Natural gas
UGI ($40; UGI)
2.3
18
21
44
(21)
8
21
18
89
51
85
Natural gas
Unitil ($41; UTL)
3.4
16
23
6
0
2
22
22
52
47
58
Diversified
Note: Quadrix scores are percentile ranks, with 100 the best. 

 


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