We’ve all heard Benjamin Franklin’s quip that nothing in the world is certain but death and taxes.
However, for a number of years now, income investors have relied upon a third certainty: utilities. Indeed, many portfolios were buoyed by the steady, above-average dividend payments offered by utilities stocks.
Unfortunately, the run-up in the market, combined with the perpetual search for yield, has elevated the prices of utilities stocks to the point that they provide a mediocre yield and a substantial chance of capital loss.
Thus, while a few investible companies remain, investors should tread carefully in this once-sought-after income haven.
Bull Market Pressures
In total, these forces have pushed the premium above the net asset value at which utilities stocks trade. This has been particularly true during the current bull market, in which utilities have been seen as safe havens for dividend seekers – even though the dividend yields available have steadily decreased and the price risks have risen.
You can see the effect of the current bull market by looking at Pepco Holdings, Inc. (POM), the electric utility for the Washington, D.C. area. In mid-2009, it was trading at $14, and its stock price was less than net asset value. Its dividend yield, based on a $0.27 quarterly dividend, was 7.7%. At that level, it represented a safe, attractive investment for income investors.
Today, POM pays the same $0.27 quarterly dividend, but its stock price has almost doubled to $27. At that level, it yields a bare 4% and is trading at 60% above net asset value. What’s more, its trailing four quarters earnings were just $0.96, so the dividend is uncovered, and the stock is trading at a trailing P/E ratio of 29x.
|Editor’s Note: Add utilities to the list of overpriced companies in today’s market. What’s an investor to do? Well, we’ve uncovered a way for ordinary Americans to get a piece of Silicon Valley’s “most valuable private company” for just $1.15. Click here now to find out how…|
And while there appears to be little chance of a significant dividend increase in the near future, there’s a substantial chance that the stock will soon trade closer to its net asset value of about $17 per share. That’s not an attractive investment.
Of course, there are a couple of companies that appear to offer better value than the norm. Southern Company (SO), an electric utility headquartered in Atlanta and operating in several southern states, yields 4.6% at its current price. It’s trading at more than twice book value, which is negative, though its quarterly dividend of $0.525 per share is fully covered by earnings with a 5% margin based on the trailing four quarters.
Furthermore, Southern is expected to increase earnings significantly by next year, bringing its forward P/E down to 15x. Finally, unlike Pepco, which has struggled to maintain its dividend in the last six years, Southern has increased dividends by a total of 20%, beating inflation and giving shareholders a yield that should increase gently (rather than remain flat, at best).
Another above-average investment is Calgary-based TransAlta Corporation (TAC). TAC is a non-regulated electricity generation and energy marketing company in Canada, the United States, and Australia that generates power from hydro, wind, natural gas, and coal.
With fewer regulations and a broader field of operation, TAC offers a 6.3% dividend yield while its shares are trading at just 35% above book value. Its past earnings don’t quite cover its $0.58 annual dividend, which, being paid in Canadian dollars, fluctuates in U.S. dollar terms. Therefore, it’s a riskier investment than Southern – but its higher yield, broader geographical spread, and lower premium to book value offset the risk to some extent.
Bottom line: Utilities companies are expensive right now, and should probably be underweighted in your portfolio. For income investors, though, a few reasonably attractive opportunities remain.