Electric Utilities: Thus Far a Relative Safe Haven

It has become harder and harder for income investors to find reasonably safe investments that pay a reasonable dividend (or interest).

In the last three months, while virtually all income producing vehicles we follow have gotten murdered, the Electric Utilities sector has been fairly insulated from the devastation.

We follow only a small universe of these utilities as we look for the highest yields in the sector which also provide a reasonable level of safety.

In particular, we follow Great Plains Energy (GXP), Consolidated Edison (ED), Pinnacle West Capital (PNW) and Progress Energy (PGN). The common shares of these companies sport current yields of 8.9%, 6%, 7.2% and 6.4% respectively. Certainly these are very respectable yields with companies that, at this moment, provide relatively good safety. Additionally, each of them has options available for those that wish to sell some covered calls for added income.

Now that we have listed these companies we wish to share our belief that while these stocks have not been 'hit' yet, unless we see a vast improvement in the economy in the next couple of months there will be substantial pain for those owning these companies as we expect falling profits and potential dividend cuts. In particular we believe that the consumer is in such poor shape that the write offs the utilities will take will be substantially higher than they have ever been before. Anecdotal evidence already says that the number of consumers charging their utility bills to their credit cards is skyrocketing.

The bottom line is that if you own electric utilities be vigilant; if you don't own them, consider waiting until seeing what the spring brings for the economy.

Disclosure: Author has a long position in GXP, no positions in ED, PNW, PGN.

Comments

[sstro:]

The utility I own hit a low of 22 on 10/8 since then it has been flirting between 25 and 30. I was worried that we would test that low yesterday but alas we didn't. It's winter in the east or it's getting really close and people have to pay their bill or they will get cut off sooner then later in this economic time. Let them pay with the plastic the utility will gets it's money from the card companies and they can deal with the collection headaches. People will forgo a lot of things to have lights and stay warm. They also have to eat so that is another sector that will survive.

2008 Nov 20 07:48 AM

[bosun.j:]

One must ask whether these utilities will continue to operate when they can no longer afford, or find the credit for that matter, to purchase the coal, gas or oil they need to generate electricity?

This guy is a real estate appraiser. Can you say sub-prime?

2008 Nov 20 07:53 AM

[john s. gordon:]

elec. utilities are voracious consumers of borrowed money for construction of facilities (generation, xmission, distribution, whatever, in today's environment of no credit available some plans will have to be shelved.

much coal is bought on long-term contracts. in the present environment of collapsing coal prices, some of these long-term contracts my be under-water.

safety during recessions is nice but if we ever return to a sensibly functioning economy utilities are not growth stocks. they do belong in a balanced portfolio along with high-quality corporate bonds.
> jack

2008 Nov 20 10:16 AM

[Tim McPartland:]

Hi Bosun---I am a lucky real estate appraiser---haven't touched business from sub prime lenders since 2003. In fact mostly doing estate and legal work now.


On Nov 20 07:53 AM bosun.j wrote:

> One must ask whether these utilities will continue to operate when
> they can no longer afford, or find the credit for that matter, to
> purchase the coal, gas or oil they need to generate electricity?
>
>
> This guy is a real estate appraiser. Can you say sub-prime?

2008 Nov 20 04:36 PM

[jarco:]

Not all electric utilities should be considered "safe", Granted, while on a different planet let alone league from GM, C, etc., investors must question why one sports a yield substantially better than the average.

Among other metrics, pay attention to a very fine print item labeled "regulatory environment" or the equivalent found in some analysts reports. Ability to raise rates for whatever reason is paramount.

Also, make note of pension liability verses assets. Since many utilities run at negative current ratios, cash is king. The need to funnel monies into an under funded pension plan compromises facilities improvements which in turn affect operating efficiencies.

Finally, how much of the debt interest is covered by earnings. For troubled companies, it may be less than 1.0. Again, cash is king whether you have it or merely need to raise some.

For disclosure, I own XEL, D, DUK, EP, POM, SO, and PGN in that order of weighting in addition to OKE (gas as opposed to electric and not a pure utility play)

2008 Nov 21 04:12 PM

[jarco:]

If you plot the last 6 mos., DJI is down 40% while most electric utilities are only 10-20% down. I had some nice gains until the tsunami hit. Check out ED, PGN, and SO. Excellent yields and good regulatory environment

On Nov 20 10:16 AM john s. gordon wrote:

> elec. utilities are voracious consumers of borrowed money for construction
> of facilities (generation, xmission, distribution, whatever, in today's
> environment of no credit available some plans will have to be shelved.
>
>
> much coal is bought on long-term contracts. in the present environment
> of collapsing coal prices, some of these long-term contracts my be
> under-water.
>
> safety during recessions is nice but if we ever return to a sensibly
> functioning economy utilities are not growth stocks. they do belong
> in a balanced portfolio along with high-quality corporate bonds.

2008 Nov 21 04:47 PM

[Dividend Gr...:]

As a proud owner of ED i could definitely say that utilities have been an outperforming factor for my dividend portfolio in 2008.

2008 Nov 23 06:13 PM

[joyboy:]

Some years ago, when I used a broker, they suggested that I sell Entergy since it did not measure up to their analysts projection for 25.00 a share. I didn't take their advice. It is presently in the 80's. It was over 100 bucks and has since taken a good hit. GXP is another one I hold. It has it's ups and downs and is presently paying a 8.70 dividend yield. One thing about it, if the consumer can not or will not pay their bill, their power will be shut off, thus keeping the utility company from constantly loosing money. For the past 20 some odd years, I have found utilities a good investment. Whenever inflation comes back again it would then be a good idea to reconsider utilities since it is pretty much a fixed rate.

2008 Dec 18 09:52 PM