Two More Ports in the Fiscal Cliff Storm

 | Nov 16, 2012 | 11:30 AM EST
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In our most recent column, we provided two stock recommendations that we believe can help investors navigate through the fiscal cliff storm. Unfortunately, we expect that the public and posturing negotiations will only heighten the market's anxiety, resulting in continued volatility and intermittent selloffs.

While we expect to see a resolution sooner rather later, and the market higher once a solution is ultimately agreed upon, we expect to see a lot of bumps in the near term.

As we recently pointed out, while this volatility risk cannot be eliminated for equity investors, it certainly can be lessened. We continue to recommend very stable, lower volatility high-yielding companies. The entry points for these high quality stocks can be particularly attractive right now due to the recent price weakness of the overall market.

One group that satisfies these criteria and recently has become more appealing with the market's post-election slide is electric utilities. Here are two that we think are selling at very attractive entry points.

We have previously written about Duke Energy (DUK), the largest regulated public utility, and the recently reported quarter does nothing to shake our conviction. Management reiterated their expectations for the year while reporting an in-line quarter. The biggest issues that the company faces are outside normal operations: the start-up and economics of a costly innovative generation project in Indiana, a full calendar of upcoming rate cases, a pending decision to repair or retire a damaged nuclear plant in Florida, and a botched management transition following a merger.

Clarity is improving for each of these issues, and the concern that any would have an extreme impact on the company's value is subsiding. The focus will soon return to successfully reaping the merger synergies and efficiently improving operating performance -- business as usual.

By the numbers, the consensus says that DUK will generate $4.28 per share in earnings this year and $4.41 in 2013, implying P/Es of 14.0x and 13.6x, respectively. As a geographically diversified, regulated electric utility, business should be relatively stable, even in a sluggish or recessionary economy. The dividend of $3.06/share is reasonably covered, and has been increased modestly but consistently over time. The company sells at a 5.1% current yield.

Bottom line, we think that DUK is reasonably valued, produces solid income, will be very protective in weak market environments and should give investors good stock price appreciation over time.

The case for Dominion Resources (D) is similar to DUK's, but the company has even fewer non-operating issues. It is primarily a regulated electric utility as well, but non-regulated businesses make up a much larger 23% of revenues. Its business base is the Midwest, Northeast and Mid-Atlantic, and falls under the oversight of more state utility commissions.

Its growth expectations are above average, thanks mainly to the superior demographics in Virginia and North Carolina. These provide the opportunity for better earnings growth and consequently higher dividend growth as well.

Dominion's most recent quarter was a slight miss and the current year will wind up roughly flat with 2011, but initial 2013 guidance was in-line with the company's long-term plan. The biggest unusual event was the loss of a customer for a major gas export terminal under development, but this should not have a major impact on the overall company, as it expects to sign replacement contracts by year-end.

Dominion's stock has come down with the market, so the stock's P/Es are 16.2x and 14.7x on consensus earnings of $3.07 and $3.38 for 2012 and 2013. While these multiples are higher than DUK's, the underlying growth profile is better. Earnings are targeted to grow 5%-6% annually over time, at the higher end of industry performance.

The current dividend is $2.11 (a 4.25% yield), and has been increased over 5% annually for at least the last 10 years. This dividend growth may accelerate, as management will be increasing its dividend payout ratio even as earnings growth continues.

To our way of thinking, D is an attractive utility, with good secular growth, an attractive dividend, and a steady, non-glamorous business that should provide stability in an unstable environment. From current prices, we believe its investors will get modest appreciation over time.



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