4 Low Beta Dividend Stocks To Buy And 1 To Avoid

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 |  Includes: AEP, DUK, EXC, SO
by: Todd Johnson

Utility stocks provide a high dividend payout based upon a risk versus reward assessment. The services are needed by U.S. citizens. The companies typically have a moat structure in their respective territories. These positions are very attractive for conservative and retired investors. In this article I recommend 4 utility stocks. I advise 1 utility stock to avoid.

Southern Company (NYSE:SO) Overview:

Southern Company is a leading producer and provider of electricity in the U.S. Southern is based in Atlanta, Georgia. It produces 42,000 megawatts of electricity and serves 4.4 million retail and wholesale customers in Alabama, the Carolinas, Florida, Georgia and Mississippi. Fortune Magazine listed Southern as one of the "World's Most Admired Electric and Gas Utility" in 2011.

Southern was also Platts 2011 "Power Company of the Year". In addition, Southern has subsidiaries that are involved in nuclear power generation and broadband fiber-optic and wireless communications. The stock has a very low .16. This means Southern's stock price moves up or down at 16% of the overall market.

Business Strategy:

Southern is focused on energy production and distribution. It also leverages synergistic business opportunities that complement its expertise, existing physical infrastructure, network, and customer base. Southern uses its financial resources to satisfy its shareholders' dividend requirements, maintain rates at competitive levels to retain and expand its customer base, and grow in a manner that benefits the communities it operates in while also minimizing environmental impacts. Southern expects to grow earnings at 5%-7% in the coming years.

Financials:

For its fiscal year ended December 31, 2011, Southern reported full-year revenue of $17.7 billion, operating income of $4.2 billion, and net income of $2.3 billion with a 13% net margin. Relative to fiscal 2010, revenue was up 1.1%, operating income was up 11.3% and net income was up 11.2%.

Dividends:

Southern has a long history, dating back to 1948, of never missing quarterly dividend payments. In its most recent fiscal year ended 2011, Southern declared dividends of $1.89 which represent 73.5% of its full year earnings and a dividend yield of 4.2% as of February 9th closing prices.

Shares:

Southern shares were trading in the $44 range as of early February 2012 with a 52-week range of $35.73 to $46.69. Southern sports a market capitalization of $38.1 billion, a price to earnings ratio of 17.2 and a price to book ratio of 2.17x. Shares have delivered a 12.3% return on equity over the past 12 months.

Peer Group:

Southern has a higher market capitalization than most of its peers. The below table highlights the market cap of its peers, including other energy producers and distributors such as American Electric (NYSE:AEP), Duke Energy (NYSE:DUK), Exelon (NYSE:EXC), and Progress Energy.

Action:

The Federal Reserve Chairman, Bernanke, has announced the Fed Funds rate should be 0% through 2014. I believe this has provided some stock price support to the utility sector. I would buy Southern up to $45 for a 4.2% yield. I would sell monthly covered calls, strike price $45, against the position to maximize return.

Progress Energy (PGN)

Progress Energy is in merger discussions with Duke Energy. Progress Energy is based in Raleigh, N.C. The company has more than 22,000 megawatts of generation capacity and approximately $10 billion in annual revenues. Progress Energy serves over 3.1 million customers in North Carolina, South Carolina, and Florida. Progress offers a 4.6% dividend and is a compelling valuation. Progress's beta is .18.

Duke Energy

Duke Energy is a holding company for utilities with 4.0 million electric customers. The company has 500,000 plus customers. Duke Energy and Progress Energy have announced a merger agreement to combine the two companies. Duke increased its dividend in June 2011. It offers a solid 4.7% annual dividend yield. Duke's beta is .32.

American Electric Power

American Electric Power Company serves about 5.3 million customers. The company has 10 operating utilities. The utility offers generation, transmission, and distribution of electric power to retail customers. At the current $39.33 price per share, I would sell a AEP Mar 2012 40.000 call (AEP120317C00040000). This would bring in $35 per contract. The quarterly dividends are 47 cents per share, so the $35 cents could boost the net yield per 100 shares. The stock's beta is .35.

Avoid Exelon Corp

Exelon has one utility largest portfolios of electricity generation capacity. The company is the largest owner and operator of nuclear plants in the U.S.

2013 will be a difficult year for Exelon due to the power markets' hedges. The power markets are unfavorable, so the hedges that Exelon put in place are at lower prices. This will reduce 2012 earnings. Assuming this impact is correct, I believe Exelon will not be able to increase its dividend until 2013 at the earliest. The last year Exelon increased its dividend was 2008.

On April 28, 2011, Exelon and Constellation announced that they signed an agreement and plan of merger to combine the two companies in a stock for stock transaction. This continues to move forward. The January 25th, 2012, conference call highlights the level of power generation hedges in place for 2012 through 2014.

Summary:

Southern is one of the largest electric utilities in the U.S. by revenue and market capitalization. Its dividend yield is middle of the pack relative to its peer-range of 3.2% to 5.3%, largely because Southern's shares are higher than its peers. Its higher market capitalization reflects investor approval of its tightly run operations and overall business strategy. As of February 2012, its shares were near multi-year highs, reflective of the broad market rise, and could be in for a slight correction.

While it has a stable revenue and client base, its earnings are influenced to a moderate extent by external factors such as the cost of fuel, energy prices, weather patterns and the strength of the U.S. economy in the southeast. Southern has historically proven its commitment to dividends and is a solid core holding, especially if shares are bought at a reasonable valuation.

I recommend conservative investors buy Southern, Duke, American Electric, and Progress Energy. I would recommend selling covered calls to enhance your returns.

I recommend investors avoid Exelon stock until after 2012 due to its power generation hedges. The 2012 dividend is likely to not increase until after its pending merger and the hedges are reduced in 2013 through 2014.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.