The World's
Safest Stocks
by Roger S. Conrad, Editor
Utility Forecaster
Political
crises in the Persian Gulf and the White House. Continuing fallout from
Asia's economic turmoil. Potential inflation and deflation. Record-high
stock valuations and volatility. There's plenty for investors to be concerned
about these days, even as stocks reach record high ground.
Unfortunately,
only cash offers complete protection from all these risks. But the very
highest quality energy, communications and water utilities will preserve
and grow your principal in all but the worst imaginable circumstances, while
paying solid yields. And, unlike cash, owning them will keep you in the
game for further bull market advances.
Below,
I spotlight eight of these wonders and show how they stack up against each
of the major risks facing the investment markets in general and utility
stocks in particular. All eight are safe enough for even the most conservative
and they feature growth potential that will satisfy the more aggressive
as well.
Each
is also a Utility Forecaster Core Holding.
Uncharted Waters
For
stocks, the 1990s are unique for more than just record-high returns. It's
also the first time in memory that time-tested benchmarks of value -- such
as dividend yields and price-to-earnings ratios (P/E) -- have become pure
abstractions on Wall Street, rather than natural ceilings and floors for
stock prices.
With
no point of reference for what a fair price is, stocks are sailing in uncharted
waters, driven by the changeable winds of so-called "momentum players"
who trade based on growth trends in profits and prices. Stock prices have
become increasingly volatile, prone to swift selloffs as well as sudden
advances.
In
these uncertain seas, the eight utilities in the table are still well anchored
in value, as Graph I shows. Their average P/E is less than 60 percent of
the average S&P 400 stock, despite comparable growth prospects, and
their average yield is more than three times greater.
Low valuations protected the group well when the Asian crisis triggered
a brief stock market breakdown in the fourth quarter of 1997. While worried
investors sold off the market's high flyers, my eight stocks rang up an
average return of 18.3 percent.
Looking
ahead to the rest of the decade, many things could trigger a market slide,
especially given stocks' lofty valuations. And, as graph II shows, even
the great utilities probably won't dodge all the damage. But they will avoid
most of it, and they're sure bets to be at the forefront of the recovery.
Inflation Beaters
The
great U.S. bull market of the 1990s has been driven in large part by a "goldilocks"
economy: Growth hasn't been fast enough to spark inflation, or slow enough
to send unemployment to unacceptable levels. Interest rtes have stayed low,
making utility dividends more valuable and pushing their stocks higher.
If
this healthy state of affairs continues indefinitely, stocks -- including
utilities -- should keep pushing to new highs. History shows, however, that
sooner or later the good times will end with either a burst of inflation
or possibly even deflation.
When
inflation stirs, only stocks that can outgrow it will thrive. Historically,
utilities have not proven up to the task, selling off each time inflation
has raised its ugly head in the post World War II period. The reason was
regulators' tight leash on their monopoly profits.
New
opportunities from the post-deregulation era, however, are changing the
tune for my great eight. Duke Energy, Southern Company and UtiliCorp
are all posting torrid revenue growth from energy marketing, matching consumers
and producers in unregulated markets. The three, along with Northern
States Power and TECO Energy, also have low-risk, high potential
investments in fast-growing overseas markets, which are already contributing
to the bottom line.
Inflation
brings higher energy prices with it. That will benefit Keyspan Energy and
TECO, which already derive a sizable percentage of their earnings from fossil
fuels production.
In
addition, as I pointed out in the December Utility Forecaster, electricity
generation will be an unregulated business under deregulation. That means
power prices would follow other energy prices higher, enriching major low-cost
generators like Duke, Northern States Power, Southern Company, TECO Energy
and UtiliCorp. Duke, Northern States and Southern have positioned themselves
for even greater profits by purchasing power plants outside their home territories.
Communications
giant GTE posted 9 percent revenue growth in 1997, double its early
1990s rate. With sales accelerating for everything from long distance service
to the Internet, growth will only accelerate in coming years. American
Water Works is pushing up its profits with acquisitions of water systems
nationwide.
Keyspan
Energy moved two giant steps closer
to acquiring the natural gas operations of Long Island Lighting last month,
as New York and federal regulators approved the merger. The Internal Revenue
Service must now give its blessing by issuing a favorable tax ruling on
the deal, expected by April.
Keyspan's
profits soared 23 percent in its fiscal first quarter (ended December 31,
1997), powered by cost-cutting and profits in energy production. The company
further shored up future profitability last month by signing on Enron to
manage its natural gas needs. A bit ahead of itself now, Keyspan stock
is a buy on dips to the low 30s.
Stock Spotlight: Utilicorp
If
you have a competitive mindset, the upside of deregulation is far more than
any downside", asserts Richard Green, CEO of Core Holding UtiliCorp.
In 16 years at the electric and gas ute's helm, he's proven that statement
beyond the shadow of a doubt.
While
other utes downsized in 1997, UtiliCorp more than doubled its revenues with
explosive growth in new businesses and solid performance in old ones. Best
of all, Green's post-deregulation expansion strategy had its first real
impact on the ute's bottom line: Earnings grew 8 percent and are firmly
on track for double-digit yearly growth well into the next century.
The
company's core remains its regulated electricity and natural gas retail
"delivery" business, an eight-state, low-cost utility empire built
by Green in the late '80s. The bulk of growth, however, is coming from new
subsidiaries that are reaching critical mass.
Chief
among these is Aquila Energy, one of America's top five marketers of electricity
and natural gas. Marketing lines up energy producers and consumers. It's
a low margin business requiring large, well-managed volumes to be profitable.
Unlike
most of its competitors, Aquila has achieved that riding a near tripling
of gas sales and a 10-fold gain in electricity sales to a 49 percent overall
earnings gain last year.
As
utility deregulation spreads nationwide, Aquila's opportunities for growth
will only increase. Meanwhile, profits are rising from other ventures, including
low-risk stakes in Australian, British, Canadian and New Zealand utilities
and the ute's national EnergyOne brand.
Recently
breaking out to a new trading range in the mid-30s, the stock still sells
for only 14 times estimated 1998 earnings and a 5 percent-plus yield. UtiliCorp
is a great buy up to 36, or anytime through its direct stock purchase plan
(800-487-6661; www.utilicorp.com).
Last
year was the first year post-deregulation opportunities began to have a
real impact on these companies' bottom lines. But by 1999, the additional
sales and profits will accelerate these utes' overall growth rates into
double-digits. That should enable them to meet and beat a rise in inflation
for the first time since the early 1960s.
Dodging Deflation
Deflation,
an environment of falling prices, is the third great worry on Wall Street
today. The last case of it in this country was the horrific Great Depression
of the 1930s, when the stock market melted down, industry all but shut down
and millions were thrown out of work. Fortunately, even in this worst of
all possible worlds, my eight picks should fare well.
Today's
deflation threat is centered on the threat that Asia's economic meltdown
could resume in coming months. That would further collapse the region's
demand for exports from other countries, including raw materials imported
from other emerging economies. The sharp decline in global demand for goods
could then trigger economic slowdowns throughout the emerging markets, eventually
spreading even to developed nations like the U.S.
In
a worst case scenario, the deflationary cycle would feed on itself, as it
did during the 1930s. Longer unemployment lines would mean ever-fewer consumers
to buy goods to keep the factories open, leading to more downsizing. The
record debt burden held by the average American would accelerate the disaster,
with falling incomes forcing defaults and possibly shaking the banking system
to its knees.
The good news is the chance of such a catastrophe is quite remote. The explosive
rally in Asia's stock markets in early 1998, for example, makes a sharp
economic recovery in the region likely by later this year. My eight picks,
however, will provide great insurance should the unspeakable become reality.
For starters, all are dominant providers of essential services. You can
cancel the family vacation, drive a used car or move to a smaller home.
But try going without electricity, natural gas, running water or a telephone.
Utilities' indispensability enabled them to actually increase profits during
the early years of the Great Depression from 1929-31, when the average industrial
company's earnings fell in half.
All eight of these utes are low cost providers with a high reliance on the
residential users of their service, the group least likely to cancel or
curtail demand. Except perhaps for Keyspan, whose service area covers parts
of suburban New York City, these ute also serve the most economically healthy
regions of America, where the fallout from global catastrophes is always
felt last. All except American Water Works and UtiliCorp boast bond ratings
that are firmly in the investment grade camp, and all eight are anchored
by high levels of free cash flow.
In
other words, it would take quite a deflationary storm to blow these mighty
oaks down. Best of all, mild deflation would almost certainly drive down
interest rates further, building a powerful floor under their prices and
very likely pushing them higher.
Stocks for All Seasons
The
eight stocks in the table have one other weapon that ensures their good
health in any economic environment: Savvy management with a vision for where
their industry is headed and a clear strategy to profit. That's also their
best protection against being blindsided by the uncertain impact of emerging
industry deregulation.
The
proof is in these companies' Utility Forecaster safety ratings, which
size up their strength and safety on the basis of cost, regulatory issues,
financial power and strategy.
All eight of these companies earn at least a 4- or a 4, ranking them among
the safest in their respective industries. They're not the only great utilities
out there. But when it comes to meeting the market, economic and deregulation
challenges ahead, nobody does it better. Don't let your portfolio be without
them.
Editor's
Note: Roger S. Conrad is editor
of Utility Forecaster, 1750 Old Meadow Rd., Ste. 301, McLean, VA
22102, 1 year, 12 issues, $109. The Utility Forecaster is the nation's foremost
newsletter on investing in electric, gas, water, telephone, and foreign
utility stocks, bonds, preferred stocks, and mutual funds. Conrad's low-risk
portfolio has averaged almost a 15% annual return over the past eight years
while remaining fully invested at all times.
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