Utilities: Safety and Income in Uncertain Times

Utilities may not be immune to market volatility, but many consider their regulated markets and steady dividends to be an anchor in rough seas. Several leading analysts and advisors -- all contributors to MoneyShow.com -- highlight some recent favorite investment ideas in the utility space. Jim Kelleher, Argus Research Our rating on the Utilities sector is Over-Weight. In an ultra-low interest-rate environment for Treasury and even corporate fixed-income investments, we believe that investors will favor the safe income and steady EPS of the companies that keep the lights on. Utility stocks face headwinds from slow earnings growth, but have been performing well, partly due to lower interest rates. As the yields of relatively safer bonds decline, dividend-yielding utility stocks become more attractive. We believe that residential demand for power could increase as more Americans work at home (and spend more leisure time at home) due to the coronavirus. Commercial demand may begin to recover as employees return to work. Utilities should benefit from a hybrid model in which both homes and offices will require full utility services. Given recent and potential future rate cuts by the Federal Reserve in response to the virus, we expect Utilities to receive more attention from investors in the hunt for yield. Large-scale solar investments may provide rate-base growth for utilities going forward, as regulated utilities provide solar power at about half the cost of rooftop solar, according to the Edison Electric Institute. Utilities also note that solar projects are zero-emission, and are seeking reasonable allowed returns on their investments. Dominion , Duke Energy , NextEra , and Southern Company are increasingly looking toward rate-base, utility-scale solar. About 58% of installed solar capacity is at utilities, with nonresidential (25%) and residential (17%) making up the balance. Overall, we think the primary attraction of utility shares is steady and moderately growing income. We also believe that most utilities in our coverage group have secure dividends and will be able to access the capital markets for external funding as balance sheets remain underleveraged. We see the most attractive utilities as those that are able to innovate while also lowering costs. We like Southern's dividend yield of 4.4% in the current low-interest-rate environment. The company has a well-run base of regulated utility assets and has recently divested assets to focus on core operations. It now expects more consistent mid-single-digit EPS growth. Southern's balance sheet is solid. The dividend payout ratio was 54% in 2019, well below the peer average of 67%. On the valuation fundamentals, the shares recently traded at around 16.5 times our 2020 EPS estimate, in the lower half of the five-year historical range of 13.6-23.0 and below the peer average of 18.3. The price-to-book multiple of 2.0 is also below the midpoint of the historical range and slightly below the peer average of 2.1. Marty Fridson, Forbes/Fridson Income Securities Investor Southern Company is one of the nation's premier energy utility companies. Operations include electric transmission and distribution lines and more than 80,000 miles of natural gas pipeline. SO provides affordable energy through its operating companies, Alabama Power, Georgia Power, Gulf Power, and Mississippi Power; natural gas distribution through Southern Company Gas; and power generation through Southern Power. The Southern Co. 4.95% Fixed Rate Junior Subordinated Notes are callable at the company's option, anytime on or after the 01/30/25 initial call date at par plus accrued interest. It is an exchange traded bond. Par value is $25. This investment is suitable for low- to medium-risk tax-deferred portfolios. Distributions are classified as interest and taxed as ordinary income. Buy up to $26.95 for a current yield of 4.59% and a 3.03% yield to call. Edison International is the parent company of electric utility and non-utility subsidiaries that generate and distribute electric power, in addition to providing energy services and technologies, including renewable energy. EIX's primary subsidiary is Southern California Edison, one of the largest U.S. electric utilities. Southern California Edison is not to be confused with Pacific Gas & Electric , the electric utility that was forced to file for bankruptcy due to forest fires. EIX continues to make significant progress toward mitigating wildfire risk. EIX reported second-quarter 2020 adjusted net income of $375 million or $1.00 per share, missing analysts' $1.11 estimates. Core earnings were adversely affected by higher interest expense. Total revenues of $2.99 billion fell short of estimates but improved by 6.2% from a year earlier. Dividends on this common stock are qualified and taxed at the 15%-20% rate. The current annualized yield on the common stock is 5.01%. This investment is suitable for low-risk investors. Reaves Utility Income Fund -- four-star rated fund by Morningstar -- seeks to provide a high level of after-tax total return, largely through tax-advantaged dividend income and capital appreciation. UTG's strategy is to invest at least 80% of its total assets in dividend-paying common and preferred stocks, as well as debt securities of companies within the electric and gas utility industries. The remaining 20% of total assets may be invested in other securities, including money-market investments. The fund does invest directly in oil and gas companies. This investment remains suitable for low to medium-risk taxable portfolios. With this review, we are raising UTG's fair value price to $35.00 from $31.10. Bernie Schaeffer, Schaeffer's Investment Research The shares of Consolidation Edison are currently breaking out from a bull flag pattern on the charts, just above its 200-day moving average and -10% year-to-date level. The equity has added 5% so far this quarter, and now looks like a prime opportunity to bet on the stock's next leg higher. Digging deeper, there was a recent 72% surge in short interest during the past two reporting periods, of which, now accounts for nearly 4% of the stock's total available float. At Consolidation Edison's average pace of daily trading, it would take short sellers just over a week to buy back their bearish bets. There is also ample room for upgrades, should the bearish attention being to unwind. This is per the 11 covering analysts that sport a hold or strong sell recommendation on Consolidation Edison stock. Lastly, looking toward options, puts rule the roost. At the International Securities Exchange (ISE), Cboe Options Exchange (CBOE), and Nasdaq OMX PHLX (PHLX), ED's 10-day put/call volume ratio of 1.39 sits in the 82nd percentile of its annual range. Should this bearish sentiment fall off, it could push the security higher. Traders should target a move up to $88, with a stop below $79. Paige Meyer, CFRA Research's The Outlook Sempra Energy , carries CFRA's highest investment recommendation of 5-STARS, or Strong Buy. Sempra Energy is a San Diego-based multi-utility that provides electric and gas services to customers in the U.S. and Mexico. Sempra has experienced material changes to its business over the past couple of years after activist investors Elliot Management and Bluescape Resources announced they had made recommendations to SRE's board and nominated six directors to the board. The company initiated a strategic portfolio review and an operational review. In response, Sempra sold off numerous assets to focus on its core operations. It divested its U.S. renewables business (solar and wind) in 2019, two natural gas storage assets in 2019, and its South American utilities businesses in 2020 -- Chile and Peru. Sempra reinvested capital from these asset sales in expanding its operations in Texas, limiting its needs to access the capital markets. As a result of this strategic repositioning, we forecast EBITDA margins will increase to 42.9% in 2020 and 44.7% in 2021, up from 37.5% in 2019. Our Strong Buy opinion reflects our view of strong EPS growth -- driven by new projects entering service and SRE's discount-to-peers valuation. SRE's utility segments have various projects in development that will likely add to the utility's rate base. Also, Sempra has filed for rate increases covering the period from 2019 through 2022. We see the startup in 2020 of the Cameron LNG export project boosting EPS, with Cameron LNG Train 3 substantially completed. We note the LNG revenues will come from take-or-pay contracts (the customer pays for the capacity that has been set aside for it at a fixed rate, whether used or not), which are lower risk. Meanwhile, Sempra's California utilities have decoupled revenues with no earnings exposure to changes in volumes or commodity prices, which will likely be beneficial during the coronavirus pandemic slowdown. To mitigate wildfire risks from operating in California, SRE procured more than the required $1B of wildfire insurance under a balanced program to comply with AB 1054 wildfire fund requirements. SRE has invested more than $2B in wildfire mitigation since 2007 as part of its 'Fire Safe 3.0' program. Our 12-month target price of $154 is 19.9x our 2021 EPS estimate, or a premium to peers, warranted by prospects for an above-peer three-year EPS growth rate and improving margins following the strategic repositioning. Risks to our recommendation and target price include unfavorable regulatory decisions, weaker results from international and unregulated operations, weaker economic conditions, and an unexpected rise in interest rates. Neil Macneale, 2 for 1 Stock Split Newsletter In choosing the latest addition to our stock split index, we had four split announcements to consider -- Rush Enterprises , McCormick & Co. , NetEase and NextEra Energy . Suffice it to say our ranking algorithm scored NextEra Energy well above the others. NextEra Energy is one of the largest electric power and energy infrastructure companies in North America and a leader in the renewable energy industry. It does business as Florida Power and Light, a regulated utility; the company is also the world's largest generator of renewable energy from the wind and sun. Of the five largest U.S. electric utilities, NextEra has been the only one with a rising stock price over the last year, apparently due, in large measure, to the growing realization that renewables are where the industry will be heading, with NextEra already in the lead. The P/E is higher than I like. It can be argued this is balanced by the steady growth in earnings, a five-year dividend growth of over 11% per year, and a debt-to-capital ratio below that of all its peers. Returns on investment, equity, and assets are all higher than industry averages. The icing on the cake is a very low beta, a number suggesting we should see much lower volatility in the NextEra stock price when compared to the overall market.

Utilities: Safety and Income in Uncertain Times

As the yields of relatively safer bonds decline, dividend-yielding utility stocks become more attractive.

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