3 Utilities With Attractive Upside, Limited Downside

Includes: DUK, KMI, PPL
by: Takeover Analyst

What follows is a list of utilities with various degrees of upside. This industry is attractive to risk-averse investors due to the combination of high dividend yields and low betas. On the flip-side, however, upside is not the greatest. The lack of reward stems from regulatory hurdles, interventionist price controls, and limited growth opportunities. Utilities will be particularly hurt if the Obama administration is successful in more than doubling dividends taxation. If the 15% qualified rate is not extended, Obama is aiming to have the rate bounce to 39.6%. Utilities and other high dividend-paying companies will be particularly hard hit; but, the stock market in general will fall, ceteris paribus. I recommend investing in these companies only if you are risk-averse and believe dividend taxes will not be hiked.

Duke Energy (NYSE:DUK)

Duke trades at a respective 16.6x and 14.4x past and forward earnings, with a dividend yield of 4.7%. Consensus estimates for Duke's EPS forecast that it will decline by 2.7% to $1.42 in 2012, and then grow by 4.9% and 6.7% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $1.43, the stock would hit $22.88.

I am optimistic about how the merger with Progress Energy (PGN) will unlock cost synergies, but regulations limit, if not completely limit, pricing power. Financial performance was strong in FY2011, with adjusted diluted EPS of $1.46. This was only marginally higher than last year's results, yet still strong in light of a challenging environment.

El Paso (EP)

El Paso trades at a respective 161.4x and 23.2x past and forward earnings, with a dividend yield of 0.1%. Consensus estimates for El Paso's EPS forecast that it will grow by 20% to $1.20 in 2012, grow by 7.5% in 2013, and then fall by 23.3% in the following year.

Of the three stocks highlighted in this article, El Paso is the only one that has more volatility than the broader market. Kinder Morgan (NYSE:KMP) agreed to purchase the company, which makes El Paso Pipelines (NYSE:EPB) attractive in light of the assets it will pick up as a result of the deal. The dividend yield is nevertheless virtually nonexistent.

PPL Corporation (NYSE:PPL)

PPL trades at a respective 10x and 11.2x past and forward earnings with a dividend yield of 5.3%. Consensus estimates for PPL's EPS forecast that it will decline by 14.3% to $2.33 in 2012, grow by 3.9% in 2013, and then fall by 10.3% in 2014. Assuming a multiple of 13x and a conservative 2013 EPS of $2.40, the stock would hit $31.20 for 15.2% upside.

A large portion - in the neighborhood of 70%-- of PPL's profit comes from regulated businesses, which are estimated to have a CAGR of around 8% over the next half decade. Leverage toward retail distribution grants the company an attractive amount of safety and high margins. The high dividend yield of 5.3% further limits the downside.

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