Dividend Stock Wars, Utilities Edition: Consolidated Edison And American Electric Power

| About: Consolidated Edison (ED)

I'm pitting two stocks together from a sector that's long been recognized as the bread and butter of an income-oriented portfolio. Namely, utilities.

Stalwart, defensive and dividend growth-oriented, they're classic stocks for good reason.

And Consolidated Edison (NYSE:ED) and American Electric Power (NYSE:AEP), with massive market caps and established operations, are among the biggest, better-known utility stocks out there. But, as I'll reveal below, there's one other major reason I picked these stocks and not others.

So let's get cracking…

~Round 1: Simple Business

The rule is easy: The simpler the business, the better the investment.

This holds especially true for income investing. The fewer the moving parts, the fewer the risks - and the more likely you'll be getting that dividend next quarter (and the next, and the next). And one of the primary reasons dividend investors find the utility sector so attractive is its simplicity. Individuals, businesses and organizations need water, gas and electricity. Utility companies sell it to them.

There are two complicating factors, however.

First, utilities are subject to government regulation…

Regulatory environments often change over time, and these changes don't necessarily have a utility's best interest in mind. In other words, earnings might take a hit for reasons beyond a company's control. This affects Con Ed and American Electric on a relatively equal basis. The former primarily serves New York, and the latter derives nearly 30% of its revenue from Ohio. Both areas are known in the industry to be among the toughest and more unstable regulatory environments in the country.

Second, utilities often deal in commodities, like oil and natural gas, whose long-term price changes are anything but easy to predict. Additional regulation surrounds the use of certain sources of energy generation. For instance, coal-burning plants are forever under the thumb of the EPA. Again, what happens in governmental committee today could mean company losses tomorrow.

Case in point: Back in February, American Electric agreed with the EPA to convert three of its power plants from coal to natural gas by 2015. But the cost of compliance proved to be prohibitive, so now the company is opting to shutter those plants instead.

In the end, because American Electric relies on coal plants in a big way, and Con Ed not at all, the latter has the upper hand at avoiding expensive regulatory decisions.

Advantage: Consolidated Edison

~Round 2: Steady Demand

Utilities are widely known for being about as recession proof as you can get. Everyone needs water, gas and electricity no matter what's happening in the economy at large.

But, once again, regulations are liable to muck it up. So even if the implicit demand rises steadily - Morningstar estimates this growth at about 1% annually - it won't always translate into steadily rising revenue.

American Electric's plant closings cited above show just why this is. Tack on regulated rate cuts that come and go, and it's no wonder why revenue is liable to take it on the chin.

So while populations and service areas continue to grow both for Consolidated Edison and American Electric, three-year revenue growth for the former was a tepid 3.48%, and the latter's dipped into negative territory at -2.21%.

Advantage: Draw

~Round 3: Valuation

There's an overwhelming reason I picked Con Ed and American Electric over other utility stocks.

Back in May, I pointed out that the utilities sector is suffering from overvaluation. Indeed, the valuation of most utilities is heavily overpriced. Yes, it can be worth paying a bit more for high dividend growth or solid, defensive performance. But there's a limit. And the utility sector is far beyond it.

Right now, the average utility trades for more than 35.8 times earnings. That's over twice the price-to-earnings (P/E) ratio of the S&P 500.

Luckily, American Electric Power and Con Ed are anomalous bargains in the sector, trading at just 18.7 and 17.6 times earnings, respectively. In other words, while both offer all the defensive and solid income potential of major utilities - and remain reasonably priced - Con Ed has a slight edge.

Advantage: Consolidated Edison

Round for round, with one draw and two wins for Consolidated Edison, American Electric has a little catching up to do.

~Round 4: Minimal Need for Credit

The more pressure there is to pay down debt and reduce payments on interest, the more likely management will be to give cash distributions the shaft.

Because of the potential squeeze that debt can put on cash distributions, finding those companies with manageable amounts of debt on the books should be a priority when looking for long-term dividend investments.

Both companies are levered up substantially, however. American Electric is currently saddled with $3.2 billion in short-term and $15.6 billion in long-term debt. Con Ed carries a relatively lighter load, however, with $1.9 billion in short-term and $10.5 billion in long-term debt.

Advantage: Consolidated Edison

~Round 5: Earnings Buffer

Just like cash, earnings can provide a buffer as well. We can track this buffer by calculating a company's dividend payout ratio (DPR), which is earnings per share divided by the annualized dividend.

As a general rule, I recommend investing in companies with DPRs of less than 80%. The lower the percentage, the less chance there is of a cut if earnings go south.

On a trailing 12 month (TTM) basis, both companies come in under the bar. American Electric's DPR checks in at 76.4%, while Consolidated Edison undercuts it by a hair, with a DPR of 71.1%.

Advantage: Consolidated Edison

~Round 6: Price Performance

There's more to a dividend investment than just payouts, of course. We want a stock that appreciates in price, too. You can put all the money you want in my account today, but if the stock tanks, it isn't going to matter.

Having said that, utilities aren't growth stocks. Expecting more than a moderate rise in price is simply unreasonable. (This is, incidentally, exactly why utilities pay dividends - to attract investors to otherwise lackluster stocks.)

In that regard, there aren't any fireworks here for American Electric or Con Ed. The former clocked gains of 9.9% year to date and the latter did only slightly better, returning 11.2% over the same period. While they both look miserable compared to S&P 500 gains of 20% YTD, they're still right in line with average gains for regulated electric utilities, which are lumbering along at a meager return of 10.5%.

Advantage: Consolidated Edison

~Round 7: Dividend Yield and Growth

It doesn't get any more basic than yield and growth, so I'll spare you the 101…

Like I said, higher-end yields are to be expected from non-growth-oriented operations. And neither company disappoints. Both sport yields nearly twice the S&P 500 average of 2.2%, with Con Ed's yield coming in only slightly lower than American Electric's, at 4.06% and 4.31%, respectively.

When it comes to dividend growth, however, there's a whole lot to be desired…

Con Ed's average three-year dividend growth rate (DGR) of 0.93% barely registers. And while American Electric's three-year DGR clears the low bar set by Con Ed at 5%, it's hardly what I'd call a dividend growth stock.

Advantage: American Electric

Let's Go to the Scorecard…

After seven rounds, the winner is clear. Consolidated Edison gave American Electric a swift beating, winning five out of the seven rounds. Just more confirmation of why Con Ed has been a consistent go-to utility stock for income-seekers.

But make no mistake, based on American Electric's slightly higher yield and greater penchant for dividend growth - and the fact that many of the rounds were close calls - it's clear that the company is more than viable for income purposes.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.