Which
utilities are safe to buy?
by Geraldine Weiss
Investment Quality Trends
Once
burned, twice shy. That's what we learn as children. And investors
in utilities stocks have been badly burned this year. Not once,
but many times. It began with the Enron debacle last year. But
creative bookkeeping shenanigans have not been the only problems.
The industry has suffered earnings warnings, ratings downgrades
and concerns about liquidity. Weak wholesale power markets and
questionable trading activities have resulted in declining cash
flow and reduced earnings. As a result, many companies have been
forced to cut their dividends. Confidence in utilities stocks
now is at the lowest point in history. Investors are angry, disappointed
and fearful. Company after company has been taken out and shot
in the stock market. Who can forget what happened to such industry
stalwarts as Aquila (ILA), Xcel Energy (XEL), TECO
Energy (TE), Allegheny Energy (AYE) and Texas Utilities
(TXU)? Perhaps their problems originated with deregulation,
when many utilities diversified into unfamiliar activities to
boost their bottom lines. The recession is partly to blame. But
these companies have weathered many recessions in the past, so
we cannot blame their problems entirely on the economy. The pity
of it is that most investors buy utilities stocks for security
and income. What they have found is insecurity and loss of income.
Many of these investors are retired, with little opportunity
to replace the losses they have suffered. What should investors
do who own utilities stocks?
We believe that most
of the bad news in the industry now has been revealed. After
the horse is out of the stable, it is too late to lock the barn
door. Many utilities stocks now are selling at all time low prices.
Many are priced below book value. (Book value is the net asset
value or liquidating value of the company.) This is not the
time to sell. Rather, this may be a good time to consider
buying some utilities that have weathered the storm and look
to be safe. Even the problem utilities appear to have bottomed.
Their prices have turned up in recent days.
Let's consider the
long-term situation. Despite current problems in the industry,
one cannot deny the future of electric utilities. The companies
may be bloody and bowed, but they will survive. Most are monopolies
in their service areas. Their importance to our life styles and
our dependence on their products and services cannot be understated.
Earnings may weaken temporarily, dividend growth may stall, but
this too will pass, and when it does the industry will be stronger
than ever with enlarged capacities and enriched experience. What
doesn't kill you makes you stronger. We look for a stronger utilities
industry in the future.
So, let's take a look
at the Undervalued category and see if there are any bargain
buys among our blue chip utilities. We will focus on companies
with attractive dividends that appear to be well protected by
earnings. There are many fine (and safe) utilities in the other
three categories in I.Q. Trends. But we will confine this
report to utilities stocks in the Undervalued category where
we are less likely to have any more unpleasant surprises, where
the downside risk is slight and the upside potential is most
rewarding.
Cleco Corp (CNL): Featured in the Mid-October issue at a price of $11 per share, this electric utility holding company in Louisiana now yields 8.3%. The $0.90 annual dividend is well protected by 12-months earnings of $1.63. This "A-" quality stock has paid dividends each year since 1935. The current payout ratio is 55%. The price is below book value. Small dividend increases have been awarded in each of the past 12 years. The price/earnings ratio is 7-to-1.
Nicor Inc. (GAS): A utility holding company that provides natural gas service in Illinois, Nicor recently was priced at $28 per share. Based on an indicated annual dividend of $1.84, the dividend yield is 6.7% and the payout ratio is 58%. The S&P Quality Rank is "B+". Small dividend increases have been awarded in each of the past 12 years. The price/earnings ratio is 9-to-1.
NiSource Inc. (NI): A utility holding company with natural gas, electric and water service in Indiana, NI recently was priced at $17 per share. The dividend yield is 7.0%. The $1.16 dividend is well protected by earnings of $1.50 per share, indicating a safe payout ratio of 52%. The current price is the same as the book value of the company ($17 per share). The dividend was increased in each of the past 12 years at a compound annual rate of 7%.
Pinnacle West Capital (PNW): This "A" quality utility holding company in Arizona is an example of a once-troubled utility that has restored its blue chip status. After suspending its dividend in the late 1980s, the company reinstated the payout in 1994 and has been a stellar performer ever since, growing its dividend at a compound annual rate of 8%. At a recent price of $24 per share, the dividend yield is 6.7%. The $1.60 dividend is well protected by earnings of $3.85 per share. The dividend payout ratio is 47% and the price ($24) is below book value ($31). The P/E ratio is 6-to-1.
Teco Energy (TE): An "A" quality electric utility in the Tampa area, TE is one of those companies that recently was hit by some unfortunate news regarding oversupply and a downgrade by a ratings agency. However, earnings are up and the dividend appears to be safe. This stock gapped down on one bad report at a price of $19 a share in August. We expect that gap to be filled in the not-too-distant future. Although the current dividend of $1.42 per share is unlikely to be increased, as it was in each of the past 12 years, it is thought to be safe. At a recent price of $12 per share, the dividend yield is 12.0%. The price is below book value of $15 per share and the price/earnings ratio is 5-to-1."
Editor's Note: Geraldine Weiss is editor of Investment Quality Trends, 7440 Girard Ave., Ste. 4, La Jolla, CA 92037. 1 year, 24 issues, $310. Trial: 2 months, 4 issues, $55.
