Are Sizzling Utilities Too Hot To Handle?

Includes: AEP, D, FE, SO
by: Stone Fox Capital

My utility holdings are making me nervous. First, utility stocks like Southern Co (NYSE:SO), FirstEnergy (NYSE:FE), Dominion Resources (NYSE:D) and American Electric Power (NYSE:AEP) have hit recent 52-week highs, with some even hitting all-time highs. Second, market analysts have become more bullish on the sector, making me more concerned the sector is too popular.

The main reason for the recent strong performance of the sector is that high-dividend-paying stocks are in favor with government bond yields at historical low rates. Combine the yield with the relative security of the sector, and the stocks have held up in this weak market.

On the flip side, most utility stocks were crushed in the 2008-2009 Great Recession. So much for being low-risk. Why are investors piling into stocks crushed in the last recession if they are selling just about all other stocks, fearing another recession?

What concerns me even more is that some of the utilities have above-market earnings multiples with revenues and earnings expected flat to down for 2012. The only way to obtain capital appreciation is to expand already expensive multiples. Sure, the dividend is attractive, but ultimately any company should be judged on its earnings yield and ability to grow earnings.

Apple (NASDAQ:AAPL) could easily have the same yield, plus the ability to grow the dividend, along with great stock appreciation. Do investors realize that SO has a higher forward P/E than AAPL? AAPL is expected to grow 22% over the next five years, and SO only 6%. Investors ought to just sell a few AAPL shares when they need cash, rather than getting dividends from an expensive utility.

American Electric Power operates as a utility generating electricity using coal and lignite, natural gas, nuclear, and hydroelectric energy. It owns and leases approximately 37,000 megawatts of generation capacity in Arkansas, Indiana, Kentucky, Louisiana, Michigan, Ohio, Oklahoma, Tennessee, Texas, Virginia, and West Virginia. The stock has a more reasonable forward P/E of 11.8, but an expected growth rate of only 4%. The 4.8% dividend yield is undoubtedly attractive.

Dominion Resources engages in producing and transporting energy through coal, nuclear, gas, oil, and renewables, including a portfolio of 27,615 megawatts of generation capacity, 6,100 miles of electric transmission lines, 56,800 miles of electric distribution lines, 11,000 miles of natural gas transmission, and 21,800 miles of gas distribution pipelines. The stock has a relatively high 15.5 forward P/E, though analysts only estimate a 3.3% growth rate. The 3.8% dividend yield is the lowest among the listed stocks.

FirstEnergy Corp operates as a diversified energy company serving approximately 6 millions customers within 67,000 square miles in Ohio, Pennsylvania, New Jersey, West Virginia, and Maryland. Though the stock has a forward P/E of 13.5, analysts expect earnings to drop over the next five years. The stock has a 4.8% dividend.

Southern Company operates as a utility company that provides electric service through coal, nuclear, oil, gas, hydro resources in Alabama, Georgia, Florida, and Mississippi. The company serves 4.4 million retail customers with approximately 42,000 megawatts of generating capacity. With a forward P/E of nearly 16 and a growth rate of only 6%, SO has a very high price to growth (NYSE:PEG) ratio. Investors clearly like the 4.4% dividend yield.

In conclusion, utility stocks have provided very appealing returns in the past, along with great dividends. Logically, though, these stocks will not provide any upside over the next few years. The dividends will be nice, but other beaten-down sectors will provide higher returns over the next 5 to 10 years. Utility stocks, however, could spike higher on any global weakness.

All information sourced from Yahoo Finance.

Disclosure: I am long FE.

Disclaimer: Please consult your financial advisor before making any investment decisions.