6 Highly Charged Utility Stock Picks for Income and Growth

 | Mar 08, 2018 | 12:06 PM EST
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Investors have fled the utilities sector over fears that rising interest rates will be a headwind to future growth. Several leading financial newsletter experts, and MoneyShow.com contributors, disagree and believe weakness in the sector is offering an opportunity.

Jeffrey Hirsch, Stock Trader's Almanac

Julius Caesar failed to heed the famous warning to "Beware the Ides of March" but investors have been served well when they do.

Tempestuous March markets tend to drive prices up early in the month and batter stocks at month end. Stock prices have a propensity to decline, sometimes rather precipitously, during the latter days of the month.

However, one sector that begins its seasonally favorable periods in March is utilities. Indeed, the utilities sector appears to be setting up for a new trade.

Last year utilities had a great year, right up until early December. After reaching a peak in early December, utilities quickly slide lower as interest rates began to move higher. From their peak in late November to the low in February, the sector shed 16.6%.

The sector is generally defensive in nature and does offer a relatively hefty dividend (3.55% as of Feb. 27). This year could prove to be an interesting one for utilities. If the 10-year Treasury yield does break out above 3.04% and continues to climb, higher rates could pressure utility shares.

However, if interest rates are rising because economic growth is accelerating, then the sector could benefit from the increased demand that could come from higher growth.

Seasonal strength for the Utility Sector Index typically begins following an early March bottom and usually lasts through early October although the bulk of the move is typically done sometime in May or early June.

With nearly $7 billion in assets and ample average daily trading volume, SPDR Utilities (XLU) is a top choice to consider holding during utilities seasonally favorable period.

It has a gross expense ratio of just 0.13%. Top five holdings include: NextEra Energy (NEE) , Duke Energy (DUK) , Dominion Energy (D) , Southern Co. (SO) and Exelon Corp. (EXC) .

The SPDR Utilities ETF could be bought on dips below $49.20. This is just above its projected monthly support. Based upon its 15-year average return of 6.4% (excluding dividends and trading fees) during its favorable period mid-March to the beginning of October, an auto-sell price of $57.58 is set.

Richard Moroney, Dow Theory Forecasts

Even in a time of rising rates, utility stocks have their place in a portfolio, as a form of diversification and source of income.

Quadrix is our proprietary quantitative ranking system, which focuses on fundamental and technical factors in assessing stocks. In this review, we identified Quadrix factors especially effective for the S&P 1500 utility sector.

For instance, utility stocks scoring in the top quintile for price/sales ratio outperformed the average stock in the index by an average of 3.4%, based on rolling 12-month periods since 1994.

Notably each of these six factors work better for utilities than they do for the broad index. Unfortunately, just a handful of utilities currently score above 80 for them. But the Value score also works for utilities, outperforming by 1.7% on average, which gives investors more options.

An electric utility, Edison International (EIX) earns a Quadrix score of 90 for price/cash flow, one of the most effective factors for utility stocks. It also scores above 60 for price/sales and price/book, two other factors that work particularly well.

The stock yields 4.1%, the fruit of Edison growing its dividend at an annualized rate of 15% over the past three years. The stock slumped in December on worries it could face damage claims for the wildfires in California, but the selling seems overdone.

UGI Corp. (UGI) kicked off a strong start to fiscal 2018 (ending September), by posting 11% higher earnings per share in the December quarter on 27% revenue growth. For the full fiscal year, the consensus forecasts 15% growth for both per-share profits and sales.

Encouragingly, analyst estimates have risen sharply since UGI's quarterly report. At less than 17 times estimated 2018 profits, UGI shares trade 15% below the median S&P 1500 gas utility stock.

Vectren (VVC) operates three regulated utilities in Indiana and Ohio, complemented by businesses that build pipelines and other types of infrastructure. In November, the company announced a 7% dividend hike, marking its largest annual increase since 1990.

Vectren has raised its dividend for 58 straight years. Meanwhile, Vectren has been considering its strategic options since receiving takeover interest, according to a Bloomberg story last August. The shares rallied in early February on a report that Vectren has kicked off its sale process.

Ari Charney, Investing Daily's Utility Forecaster

While utilities aren't exactly known for their entrepreneurialism, regulators can prompt them to turn to non-regulated businesses to find new sources of earnings growth. Of course, that comes with its own risks, namely greater exposure to the business or commodity cycles.

But if you're at the right point in these cycles, then a hybrid utility-one that has a stable base of regulated earnings with a growth kicker from a substantial competitive business-could boast superior earnings growth.

That appears to be the case for Oklahoma-based OGE Energy Corp. (OGE) . The $6.4 billion utility currently has one of the strongest earnings and dividend growth trajectories in the sector. But that's not because of its 6,800 megawatts of generating capacity or its 60,000 miles of transmission and distribution lines.

Indeed, hardscrabble "Sooners" expect their utility to do more with less. Accordingly, rate increases were so hard to come by for so long that OGE kept its dividend flat from 1992 through 2007.

More recently, however, dividend growth has averaged 9.8% annually over the past five years, and the payout is expected to continue growing 10% annually through the end of next year.

What's made the difference? In 2014, OGE teamed up with Houston-based CenterPoint Energy (CNP) to form the master limited partnership Enable Midstream Partners LP (ENBL) .

In effect, OGE Energy's contribution of its midstream natural gas assets to the joint venture took a business that once required it to spend a couple hundred million every year on maintenance and turned it into a $140 million per year cash cow.

In exchange for its assets, OGE owns 25.7% of Enable's limited partner units, 50% of the general partner and 60% of the incentive distribution rights (IDRs). The cash distributions that Enable kicks up to OGE Energy every quarter are what's powering its dividend growth.

To be sure, the utility's exposure to Enable weighed heavily on its share price during the energy crash. For its part, CenterPoint was even looking to unload its stake in the MLP, though a potential deal fell apart in December. But with energy prices rising, Enable could add meaningfully to the firm's longer-term growth, especially if its IDRs ever enter the high splits.

Meanwhile, OGE has one of the stronger balance sheets in the sector. And while regulatory relations remain challenging, they are improving. More important, OGE is one of the cheapest and highest-yielding utilities that isn't also facing some sort of crisis. With a forward yield of 4.1%, OGE Energy is a new addition to our income portfolio.

Roger Conrad, Conrad's Utility Investor

When Lynn Good took over as CEO of Duke Energy Corp. (DUK) in June 2013, the company was snared regulatory disputes while its wholesale power business and South American assets bled cash. Today, the big regulatory fights are history, and the utility has divested its risky assets. The proceeds from these sales went toward strengthening the balance sheet.

Disciplined investment in its regulated gas and utility businesses, coupled with an expanding portfolio of wind-powered and solar-power assets and interests in the Atlantic Coast pipeline project, will drive earnings and dividend growth in coming years.

The company appears close to reaching a settlement to clean up its coal-ash ponds without incurring a huge liability. Last month, Duke Energy inked an agreement with affected property owners that will result in the dismissal of lawsuits.

Passing through the savings from a lower corporate tax rate increases the odds that Duke Energy will recover at least most of the remaining $336 million in its current North Carolina rate case. Lower corporate taxes will also help the utility avoid passing through $513 million in costs related to Hurricane Irma to Florida ratepayers.

Duke Energy connected about 500 megawatts of solar energy in North Carolina last year, bringing its installed capacity in the Carolinas to 1,800 megawatts over the past three years and the company plans to install another 3,000 megawatts in coming years.

Meanwhile, the Atlantic Coast pipeline -- a joint venture with Dominion Energy (D) and Southern Company (SO) -- will deliver inexpensive natural gas from the Marcellus Shale to power plants in Virginia and the Carolinas. The project appears set to come onstream in 2019.

Duke Energy Corp. finally trades below our Buy target of $77, giving conservative investors an opportunity to scoop up shares of this high-quality utility. Duke Energy offers a solid value proposition, as well as a mid-single-digit yield and mid-single-digit dividend growth.

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