Three Utilities for Selective Shoppers, Three High Yield Ideas

by: Yieldpig

Earlier this week, utility titans Duke Energy (NYSE:DUK) and Progress Energy (PGN) announced a merger that will create the nation’s largest regulated, electric utility with nearly $37 billion in market capitalization serving over 7 million customers across six states. Did the market do back flips? Was there a ticker tape parade? After all, big M and A activity is a positive sign that things are getting better. So what happened? Basically, the market yawned and scratched itself unenthusiastically.

Maybe it was the premium or the lack thereof. In the stock for stock deal, PGN shares are valued at around 46.00 which comes to a lavish, 4% premium at best. Maybe if they had chosen the name “Groupon Energy” the offer might have been a little richer. However, if you pay attention to utility stocks even marginally, the tepid reaction shouldn’t be much of a surprise. In fact, the market has been treating the utilities this way since 2009.

Last year, the Dow Jones Utilities returned a flaccid 1.5% or so. Of course, if you throw in dividends, the story is a little better. Still, assume 5% or so and while respectable, it was a far cry from the S&P 500’s more than decent 12.73%. And if you go all the way back to what many believe was the structural bottom of March 2009, the Utilities cumulative 36% or so is no match for the S&P’s bruising +90%. Why the lackluster performance (although nearly 18% a year could hardly be considered lackluster, but when compared to an irrational and somewhat undeserved 45% it’s hard to get noticed)? Well, if you’re among the crowd that tends to “zig”, as most do, the reasons for avoidance are fairly standard: the great unknown government energy policy that is yet to be determined and the fact that utility stocks are a bit interest rate sensitive (the recent bond sell off has helped support that notion). But for those who “zag” and are looking for value, the utilities appear to be a great place to start shopping selectively.

Names? The usual suspects are typically rounded up: Southern Company (NYSE:SO), American Electric Power (NYSE:AEP), etc. Hard to get excited about SO. It’s flirting with its 52 week high and the yield has dipped below 5%. If you want to own super, high quality, SO fits that order. Just doesn’t seem to be a whole lot of value there. AEP is a little better. The yield is just north of 5%, but it too is looking over the fence at its 52 week peak. Not that that’s a bad thing. Just not terribly exciting from a price standpoint.

A better idea might be Exelon Corp. (NYSE:EXC). While the yield is slightly under 5%, the stock trades at 10.69 time trailing earnings. The forward P/E is around 10.5, a 30% discount to its peers. Strong ROE and earnings growth as well. The dividend payout ratio is low for the peer group as well at a comfortable 53%. PGN, though now betrothed, is still OK. The premium didn’t materialize on the announcement and by owning it, you’ll wind up with the biggest, baddest, regulated electric utility on the block.

On the fixed income side of things, there are some six year, Edison Mission Energy (an EIX subsidiary) bonds floating out around there trading at around 90 cents on the dollar and yielding nearly 10%. Yes…they are junk bonds.

No one has ever accused utilities of being sexy. But when everyone else is down 10% because they followed the herd and bought too high, 5.5% is smokin’ hot. Remember the $10 bill in the birthday card your grandmother would send you? It’s a safe bet it was part of a utility stock dividend. As far as segues go, granted, that one was pretty gross. But, as much as we hate to admit it, your grammy, or nanna or bubbe was sexy once, too. Ever seen those photos of the World War Two gals on the home front? Yowza.

Well…if that didn’t get you going…how about this week’s three lil' piggies?

“High Yield on the High Seas…”

DHT Holdings, Inc.
Recent Price: 4.92
P/E: 82
Current Yield: 8.13

The Skinny
With the resurgence in black gold…Texas tea…Persian Perrier…Saudi Soda…yes…oil…maybe some of the tanker companies are worth a look.
DHT owns and operates a fleet of nine double hull tankers that serve international routes. The company has a decent cash position with $58 million or so on the books and no debt repayments until 2012. The stock trades at an ever so slight premium to book. Stated value is about $3. The cash should help keep the yield nice and fat. And if the doom-saying handwringers are right, oil busting through $100/bbl won’t hurt. Regardless of the price direction of oil, you can also look at a tanker company similar to the pipeline guys. They’re the railroad and the dead dinosaurs have to be transported from point A to B.

The Danger
Always remember, you’re dealing with a business that transports one of the most speculated upon and manipulated commodities in the galaxy. There’s a million different moving parts. Most pressing is the rumored drop in OPEC production. That would more than likely put some pressure on DHT’s revenues. The company’s EBITDA is also a bit below its peer group. The porcine P/E is a concern as well. Also, DHT’s fleet of only 7 vessels limits their reach. A lot of ocean out there. Last, it’s a bit of an outlier, but Somali pirates LOVE oil tankers. Ransom can get expensive.

“Och…Ziff..and Away!!!”

Och-Ziff Capital Management Corp, LLC (NYSE:OZM)
Recent Price: 15.79
P/E: 1.84
Current Yield: 5.4%

The Skinny
Can you name America’s favorite media villain? If you guessed “hedge funds”, then the next few sentences are of no use to you. But, if you’re looking for an asset manager in the hedge fund/private equity space with decent yield and the potential for growth, please continue. OZM manages money for primarily institutional clients in the “alternative” investment space with about $27 billion AUM. After a bruising 2008, revenue has recovered nicely. Despite negative press, the alternative sleeve is swiftly growing as an integral component of asset allocation for large institutions and wealthy individuals. OZM is a good brand name with great performance numbers in a space that’s not so well known. Remember, this isn’t an investment vehicle available from the $7 online trade broker. Firms like OZM have pricing power and as long as big money wants hedge fund exposure, they’ll pay for it.

The Danger
The alternative investment space is fraught with risk and not for the meek. Despite the spin about “low or zero correlation”, being on the wrong side of the trade in that game can close up the shop in a day. Owning shares of a firm in that business gives you indirect exposure. Wait, make that, almost direct exposure to the risk they manage. OZM has been at it since 1994 but they’ve only been a publicly traded company for 5 years and have only paid a dividend for 2 years. And although earnings are positive, they’ve been negative for five years. Last, regulatory change is coming soon to the hedge fund industry thanks to Finreg and other initiatives. Being a publicly traded company requires a bit more transparency than the kid who just left Goldman Sachs (NYSE:GS) and set up shop in his apartment. However, OZM most likely will be affected as well and regulation is never cheap for those being regulated.

“And that’s what I like about the south…”

Southern Community Financial Corporation Capital Trust II 7.95% Preferred (NASDAQ:SCMFO)
Recent Price: 6.75
Current Yield: 12.88%

The Skinny
Hey! How about another bank trust preferred? SCMFO’s issuer, Southern Community Financial (NASDAQ:SCMF) is a financial holding company headquartered in Winston-Salem, NC. The bank’s assets a total of $1.6 billion making SCMF one of the largest publicly traded community banks in the region. The preferred, SCMFO, is callable at $10 a share. That offers the potential of a nice 32.5% upside if called (remember…trust preferreds are no longer eligible to be part of a bank’s Tier One Capital). It’s also a cumulative preferred meaning that if the issuer suspends preferred dividends, they continue to accrue and will be paid back once the dividend resumes. The issuer, SCMF, has taken their lumps as most financial institutions have. But they seem to be doing better. The bank’s deposit and funding mix has been steadily improving and they’ve brought expenses down by 13%. This is truly a speculative idea. However, outliers, if they work, tend to be more successful.

The Danger
SCMFO is genuine junk. Hell…it doesn’t even have a junk rating and shares have been beaten up pretty good. As far as the company goes, SCMF’s second half of 2010 saw asset and NPL deterioration that was worse than suspected by analysts. There is also speculation that preferred dividends could be suspended. Not a good thing if you’re holding a preferred. Also, SCMFO carries no rating. Junkier than junk as far as fixed income goes (although I would treat these more like equity). And in general, even though things have improved considerably for the economy, the headwinds are still there and most banks continue to plod along like large, wounded animals.

Disclosure: Long DUK, PGN, SO, and EXC in client accounts.