Three Electric Utilities to Own, Three to Avoid

Officially, U.S. electricity demand in 2009 is expected to be up about 1.2%. But well-known electric utility analyst Daniel Scotto’s own forecast is for demand growth to be no better than 0.2% this year. Moreover, Scotto told EnergyTechStocks.com in an exclusive interview that the U.S. electric utility industry could experience negative growth for the first time since the 1950s.

Revenue from commercial power users “is starting to collapse,” Scotto said, while industrial-customer revenue “is weakening.”

Scotto went on to list the three electric utility stocks he thinks might be the best to own, as well as three investors might want to avoid, during what is shaping up as the worst business climate for the industry in half a century.

At the top of Scotto’s list is NRG Energy Inc. (NRG), the New Jersey-based power producer that giant Exelon Corp. (EXC) has been seeking to acquire in what has turned into a hostile takeover attempt.

Scotto said, “This is as easy as it’s going to get” to make money in the electric-utility sector, based on his belief that, as he put it, “I don’t think NRG will be able to squiggle out” of getting acquired. But it’s going to take a sweetened offer by Exelon, Scotto believes, which is why he thinks NRG shares will ultimately be worth more than they are now.

While NRG’s attractiveness in Scotto’s eyes has nothing directly to do with the recession, the other two utilities the veteran 30-year utility analyst thinks investors should own – Sempra Energy (SRE) and Southern Co. (SO) – are both due to their ability to withstand the current downturn.

Scotto said Sempra is a more well-balanced company than many utilities and thus better able to withstand a sharp falloff in retail revenue. Sempra’s earnings “keep coming through,” he said, adding that the company has a “strong management.”

Scotto described Southern as a “plain old vanilla utility” with a steady stream of regulatory-protected revenue. He noted that while several other utilities are dependent to a significant extent on revenue from generation (which is falling), Southern has become “the great wire company” whose regulators aren’t going to let slip into danger.

While he indicated that he doesn’t think there is any reason to sell, Scotto said the three electric utilities investors should avoid are Duke Energy Corp. (DUK), American Electric Power Co. (AEP), and Xcel Energy Inc. (XEL).

Scotto described each as a “mega-utility” that is heavily deregulated. Thus, he said, the profit outlook for each has a high correlation to the slowdown in the economy.

Scotto said AEP has a lot of commercial and industrial demand that is going to be affected. He further said that Duke and Xcel have a high cost basis that makes them less able to withstand a falloff in revenue.

Reminded that Duke and Xcel are leaders in energy efficiency and smart grid development, and that the Obama administration could alter rules so that utilities could profit from making their customers more efficient, Scotto said that “decoupling,” as it’s called, could benefit Duke and Xcel, but probably not that much.

For electric utility investors who own electric utility stocks other than these six, Scotto said, “Stay in there” if a company is paying a good dividend, but remember that the industry offers “a lot less security” than it used to.

Disclosure: In keeping with EntergyTechStocks policy to be solely a news source, this article is presented for information purposes only.

Comments

[john s. gordon:]

cap & trade legislation is likely to interfere with profitability of some old-line utilities. we are entering a period where nimble = good.
> jack

Feb 03 08:20 AM

[Jimbo:]

I have to agree with Jack on this one. I am a former owner of Southern Company but sold out last year. The Obama administration has made ominous noise about coal based electric generation and Southern seems to have a considerable dependence on coal.

Feb 03 10:31 AM

[toomuchgas:]

It is better to go with the utility bonds. They yield more than the stocks and you are protected from earnings surprises and are guaranteed to get your money back. For instance the SRE ten year bonds are yielding better than 8% vs. the stock yielding 3%.

Feb 03 11:40 AM

[Syl:]

I feel that Scotto failed to mention OGE. Oklahoma Gas & Electric is a better utility than any one of the three he praises. I have owned OGE for a number of years and I have been well pleased with their dividends. I am an investor, not a trader. I am retired and use the money to supplement my S.S and pension.

Feb 03 08:45 PM

[prudentinve...:]

Having owned various utility stocks for over 30 years, I would suggest only a very modest exposure to the sector. The stocks hardly grow, and dividends are reduced from time to time.

As one example, I bought AEP in 1981 and still own the shares. In 1981 the dividend was $2.5/yr, but it was cut about 10 years ago, and today it is $1.64/yr. If you adjust for true inflation, the income from its dividend in terms of buying power is now roughly one-sixth of what it was when I bought the stock, 27 years ago!

Moreover, if and when interest rates rise, utilities are likely to plunge. So buyer beware.

Feb 04 07:41 AM

[jarco:]

Daniel Scotto may be well known but he's well off the mark here. DUK and XEL are two of the best positioned utliities. While contraction is happening literially everywhere, don't lose sight of near term recovery. Healthy regulatory environment, top management, and a growth service area are plusses with DUK and XEL not available elsewhere. Short of bailing out (or selling short), current position should be held.

Feb 04 01:40 PM

[jarco:]

You’re a victim of the “by and hold” disease. Many did the same thing with AT&T, GM, Ford, etc. Like anything else, investment requires continual oversight. AEP’s problems were highly predictable back then.

Gas and Electric Utilities are one of the best places for investment dollars especially for those nearing or at retirement. Safe and predictable cash flow, no competition, and a recession proof product. Food and heat.; food and A/C is hard to beat!




On Feb 04 07:41 AM prudentinvestor wrote:

> Having owned various utility stocks for over 30 years, I would suggest
> only a very modest exposure to the sector. The stocks hardly grow,
> and dividends are reduced from time to time.
>
> As one example, I bought AEP in 1981 and still own the shares. In
> 1981 the dividend was $2.5/yr, but it was cut about 10 years ago,
> and today it is $1.64/yr. If you adjust for true inflation, the income
> from its dividend in terms of buying power is now roughly one-sixth
> of what it was when I bought the stock, 27 years ago!
>
> Moreover, if and when interest rates rise, utilities are likely to
> plunge. So buyer beware.

Feb 04 01:50 PM

[Dotcom:]

Buy & Hold AT&T = oh! ok

Feb 04 06:54 PM

[Phillip Jain:]

Cramer had mentioned ED is not hurt by cap-n-trade without giving reasons.

I emailed a few Qs to ConEdison Investor Relations (they dont have a phone number), about impact of capntrade. Specifically I asked how they would be affected 2-4 years out if there was a penalty on C02 emissions and how much %age of their plants would depend.

They DID NOT REPLY!

Aug 03 12:13 AM