weiwentg (98.31)

Reflections on utility stocks

December 26, 2009 – Comments (2) | RELATED TICKERS: NST , WR , EXC

As I mentioned in an earlier post, I'm not really seeing a lot of bargains out there. I think the market has got a bit ahead of itself in general and wouldn't be surprised to see a correction. I think blue chip stocks in general are still undervalued, although there are only a few screaming bargains.

The "new normal" hypothesis holds that  stock returns are likely to be depressed for years to come. I don't know how much I buy that. However, the economic stimulus is wearing off and unemployment and underemployment are still high, which would suggest that growth in the broader economy and corporate profits are both going to be low for the next few years. In that sort of environment, investors should consider adding some relatively high-yield stocks to their portfolios - assuming the dividends are sustainable, anyway.

 To that end, I've been thinking about adding utility stocks to my own portfolio. However, again, there are not very many bargains to be had. In a utility stock, I am generally looking for a company which has the bulk of its revenues from regulated power generation (as opposed to merchant generation). I'm looking for favorable regulatory environments. I'm also looking for companies in regions that have high population growth, if possible. I'm not looking for shoot the lights out performance, but I am looking for a 4-6% yield and the prospect of about 4-6% annual growth, for a total of over 10%.

 I would like to have bought NStar (NST). The firm has an excellent operating record, a favorable regulatory environment and a growing population base in Massachusetts. However, it's also trading above what I would guesstimate as fair value right now. However, one often gets second chances in investing.

 I did buy Westar (WR) recently. This Kansas utility has about a 5.5% yield right now, and I'm guessing 4-5% annual dividend growth. While Westar's population base isn't growing much, the firm does have favorable regulatory relationships. Westar recently received approval for rate increases to cover about $3 billion worth of new capital spending to meet government mandates. Westar produces energy from coal and nuclear power. My view is that cap and trade or a carbon tax is likely to pass. A lot of places in the US use coal, and even if the effective price of coal goes up, it's not going away. There will also be plenty of time for utilities to adjust. Additionally, nuclear plants are going to be an asset, not a liability - they produce zero carbon per se. I suppose I differ from the mainstream environmentalists in this regard, but I think the dangers associated with nukes are manageable.

Speaking of nukes, I also did buy Exelon (EXC). Most of this company's generation comes from nukes. This is an atypical pick in that I'd consider their regulated operations to be weak. Most of their profits come from unregulated merchant generation, which exposes them to price risk. However, most of their power comes from nukes and Exelon has some of the lowest costs in the industry. A cap and trade environment will cause coal to become more expensive than other forms of power, which will cement Exelon's cost advantage. Should cap and trade fail, I figure that Exelon still won't make out too badly. However, I'm also not looking for this stock to be a steady dividend payer.