Which High Yield Utility Company Makes The Best Investment?

Includes: PEG, POM, PPL, SCG, SO, TPR, WR
by: Paul Zimbardo

Utility companies were the best performing sector in 2011 with fifteen percent returns as investors looked for a safe haven from the global economic turmoil. This year many utilities have underperformed the S&P 500 and appear to be attractive investments. I have been investing in high yielding utilities such as Consolidated Edison (NYSE:ED) for both income and capital appreciation. For further details on the dividend capture strategy please consult my latest article on the topic.

To focus on these opportunities I ran a screen with a focus on relative safety for the investments. I began with a specification of utility companies with dividend yield greater than four percent and an ex-dividend date within the next week. Utility companies are excellent investments because they are generally stable, cash-cow business that returns most profits to investors via dividends and share repurchases. Larger companies enjoy scale benefits and are able to profit more from smaller rate increases. While geographical differences exist for regional utilities, the underlying business is essentially the same. To provide some layer of safety I narrowed down the environment by looking at companies with market capitalizations greater than $1B, PEs between zero and 20, and institutional holding percentage of at least 25 percent. While not a precise requirement, I prefer companies that have underperformed the S&P 500 year-to-date as it indicates reduced downside relative to peers. or example, if negative macro news breaks, the stock that has declined more in the past year should ideally perform better than a similar stock with year-to-date gains. The "yield price" metric is calculated by dividing the P/E ratio by the dividend yield and attempts to gauge the relative value of the dividend. A low yield price indicates that you have an affordably priced stock given its yield. This is summarized below:

  • Dividend Yield ≥ 4.0%
  • Ex-Dividend Date = Next Week
  • Market Capitalization ≥ $1B
  • PE Ratio: 0-20
  • Institutional Ownership ≥ 25%

After applying this screen I arrived at the equities discussed below. Although I envision these as short-term trading ideas, you still need to be exercise caution. The information presented below should simply be a starting point for further research in consultation with your professional financial advisor before you make any investment decisions. My goal is to present new companies to you and provide a brief overview of their recent developments and this should not be considered a substitute for your own due diligence.

Pepco Holdings, Inc. (NYSE:POM): 5.55% Yield; Ex-Dividend 12/6

Pepco Holdings operates in Maryland, Delaware, and Washington DC and services approximately two million customers. While Pepco is around the middle of the pack in terms of market capitalization, it sports the highest yield and P/E of the screener results at nearly 5.6% and 17, respectively. The yield has remained essentially unchanged for the past quarter while the P/E has declined approximately two points. Pepco recently reported that earnings nearly doubled from 2010 but earnings thus far in 2012 have been essentially flat in the first nine months of 2012. The modest growth is primarily due to higher rates and lower costs but non-GAAP net income actually declined for the period. This can be partially explained by a strong wind storm in June but it does not justify the trend. If examining only the September 30 quarter year-over-year it appears as if the company is exhibiting strong growth Pepco's yield is high enough to compensate for the price and overall I consider Pepco to be an above average dividend capturing stock. I warned against owning Pepco in the aftermath of Hurricane Sandy and I still believe you should hold-off on buying Pepco for either dividend capturing or investing.

PPL Corporation (NYSE:PPL): 4.98% Yield; Ex-Dividend 12/6

PPL is not just a utility company in the United States; it is a global energy holding company with significant interests in the United Kingdom. Most people do not know that PPL Global services 7.7 million customers in the UK, compared with the "only" 2.7 million customers in the United States. For this reason it is unsurprising that PPL is one of the largest utility companies and has the highest market capitalization out of the screener results by a decent margin. For comparison purposes, PPL is the 181th largest company in the S&P 500 index and is similar in size to Coach (COH). Despite its wide customer base, PPL generates nearly 40% of earnings from energy supply (PPL Generation) as opposed to its customer servicing business. For a more detailed breakdown of the company's segments please review the organization structure. If you follow my coverage of utility companies you will see that there are frequently intricacies and little 'quirks' with companies that make different companies unique.

Earnings per share had been growing at PPL but fell in the recent quarter. The decline was attributed to weakness in the supply segment and higher operating expenses. As mentioned above, if you are looking for a pure play customer servicing utility, PPL would not be your choice. The Kentucky and Pennsylvania retail markets were relatively flat with slightly lower margins and decreased consumption. The UK market was a bright spot but was not strong enough to compensate for declines in the US markets. The P/E has fallen to ten and remained steady there. Dividend growth reveals a mixed picture as TTM payout ratio has declined from 65% to 48% only to have risen back to 61% after earnings declined. A 50% payout ratio is quite conservative so PPL certainly has room to break out of the dividend stagnation that has persisted since 2009. Paul Farr, CFO, specifically addressed the dividend on the quarterly earnings call:

"Given the significant attention dividends have received during this earnings season, let me end with our commitment to the dividend, which we view as an extremely important piece of our total shareowner return. The current dividend level represents a 61% payout ratio based on the midpoint of our revised 2012 earnings forecast and is much more than covered by our rate-regulated earnings. As we have been indicating, we expect modest increases to the dividend [emphasis added] through the low parts of the commodity cycle and as we deploy significant capital on our rate-regulated utility businesses. This intention is reflected in the dividend increase that we announced earlier this year. Our dividend is secure and we clearly see added flexibility for future growth as we execute on our rate-regulated growth strategy."

PPL has faced a bump in the road but I am confident in the company due to its scale and past successes. PPL is my top pick this week based upon its size, customer base, yield, and low P/E. PPL also has the lowest yield price by a wide margin as it has the second highest yield with the lowest P/E.

Public Service Enterprise Group (NYSE:PEG): 4.74% Yield; Ex-Dividend 12/5

Public Service Enterprise Group is predominately a utility that services New Jersey and has approximately four million customers. In addition PSEG has subsidiaries that generate power, invest in alternative energy, and provide energy solutions to business customers. PEG was hit had difficult expanding earnings due to lower energy prices for energy and capacity, a problem that continues to plague the company. PSEG also was devastated by Sandy (a common theme this quarter) as 1.7M of its 4.0M customers lost power. Management was very transparent on the quarterly earnings call and essentially estimated that Sandy could have more than a $.10 per share total cost on EPS ($.05 in previous storms and Sandy was twice as devastating). Given that PSEG reported $.75 EPS of operating earnings in the recent quarter, the cost will be material.

Since this is not just a typical customer servicing utility, different segments of it require through analyses. PEG announced a 3.6% increase in the dividend earlier this year and management hinted at plans to increase the dividend more in the future; however, it has been unchanged since February. The payout ratio still sits slightly above 50% but management will have trouble growing the dividend if earnings continue to slide. The only growth that management was able to mention was .8% of "weather normalized growth" so it appears that the future will be tumultuous for the company.

Westar Energy Inc. (NYSE:WR): 4.66% Yield; Ex-Dividend 12/5

Westar Energy is the largest utility company in Kansas and services approximately 700,000 customers. Westar echoes a familiar theme as most utility companies have been recently: slight revenue increases were mostly offset by increases in operating expenses. Westar started off fiscal 2012 with a 4.5% increase in revenue and 19.4% increase in net income. Revenues and income have continued to inch higher during the year but EPS has dipped slightly. As with many of its peers, a three percent dividend increase was announced but there has been no growth recently. In addition to the dividend payment, the company recently completed its redemption of preferred stock that was yielding approximately 4.5%. This is slightly puzzling since the preferred yield was lower than the common yield and the increase in available cash could have an impact on possible common dividend increases.

SCANA Corporation (NYSE:SCG): 4.33% Yield; Ex-Dividend 12/6

SCANA Corporation is another energy-based holding company; however, SCANA is much more typical in that the majority of earnings relate to serving customers. SCANA has diversified interests into telecommunications and fiberoptics technologies but over eighty percent of earnings relate to its South Carolina Electric & Gas Company. Financial performance was improving through June relative to 2011 but all three operating segments exhibited revenue weakness but operating income actually rose due to the company's continued ability to control costs. Mild weather trends continue to drag the top-line down but should eventually reverse.

The company recently won approval to build nuclear reactors, joining the Southern Company (NYSE:SO) as one of only two companies to receive approval in years. This is one of the trickier geographies for utility companies because weather swings can be more volatile so I suggest considering other utility companies for an investment. SCANA is essentially an average utility in a crowded space.

The information presented has been summarized below.

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Disclosure: I am long ED. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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