Yield, Value, Safety With Utilities - Redux

by: John D. Thomason

Just about one year ago I presented the first article of what was to become my "Yield, Value, Safety" series, focusing on utilities meeting the requirements implied in the series title. Now, with the benefit of hindsight, I believe it would be useful to review the same stocks once again, to see how my picks and pans worked out, and more importantly, to see how my approach could be improved going forward.

A link to the original article is provided here. To summarize, I reviewed 36 utilities in total, limiting the field to U.S. utilities organized as C-corporations. My first-level eliminator was to dismiss stocks yielding less than 4.25%. That eliminated 16 firms. My next-level eliminator was to dismiss firms with a payout ratio exceeding 80%, which dropped 7 more. I also eliminated any firms that had not increased the dividend in the past five years, or worse, had cut the dividend in that time period. This dropped two more. That left me with 11 "finalists", which I then reviewed in detail, considering a number of factors. Of these 11, I wholeheartedly recommended 3, I inexplicably skipped another that I intended to recommend, and less enthusiastically, I recommended 2 others. I then had second thoughts about dismissing a number of promising candidates that were yielding less than my cutoff level of 4.25%, but were above 4%. To be sure I had not overlooked any great companies, I looked at 10 more firms that fell into this group in some detail. That review identified 4 more that were indeed worthy candidates, if they could only be bought at prices a little bit lower than they were then trading at. After including these 4, I had considered 36 stocks, and ended up with 10 I could recommend.

As far as lessons learned, the main lesson is to be wary of stocks yielding more than the norm, and avoid stocks that have not increased the dividend in a long while, or have not been regular with dividend increases. If I had applied this lesson, I would not have recommended Exelon (NYSE:EXC), which had not increased the dividend since 2008, and Entergy (NYSE:ETR), which had increased the dividend only twice in the prior five years, and not in a predictable, regular fashion. With the Fukushima nuclear disaster freshly in mind, I focused on the nuclear aspects of these two utilities, and believed they represented a contrarian opportunity. While the nuclear risk was and is a concern, the real risk was that the anticipated competitive cost advantage of nuclear over fossil fuel powered generation might not be realized, and their dividends might be vulnerable. As most income investors now are aware, EXC cut the dividend 41% recently, and ETR may follow suit in the next year or two. Avoiding stocks that are not increasing the dividend steadily may be the main lesson to be learned in this exercise. A corollary is to be suspicious of an outsized yield when compared to peers. Further, as long as the yield is in an acceptable range, one should focus on other qualitative aspects when evaluating alternatives, and avoid letting a slight yield shortfall have an undue impact on the evaluation.

I still believe that the high-level qualifiers of yield, payout ratio, and dividend history are useful when trying to trim down a long list of candidates to a manageable size. I'm just saying one should be flexible, and should not let a tiny miss on the high-level cutoff qualifiers cause a promising candidate to be bypassed.

I then took the entire list of 36 stocks, and started all over again. I eliminated those with yield well under 4%, payout ratio over 80%, and a static or irregular dividend increase history, to identify a new group of 17 "finalists". I then evaluated these in more detail to identify the best candidates. This time around, I ended up with 13 stocks that I can recommend. Frankly, all are trading above where I would be an enthusiastic buyer, but that is true for nearly all quality stocks today. I will now provide a brief synopsis of each of the 36 stocks, indicating how I view the stock now vs. how I saw it a year ago. For the 17 "finalists", I will present the price as of the 3/22/2013 close, the current yield, and the date of the last increase. I will also present via tables the detailed evaluation criteria I used for the "finalists", which were evaluated in more detail after passing the higher-level screens.

Utility Stocks I Can Recommend.

American Electric Power (NYSE:AEP) - Recommended then and now. Price now is $47.86, yield is just 3.9%, and the last increase was 11/8/2011.

Public Service Enterprise Group (NYSE:PEG) - Recommended then and now. Price is $33.41, yield is 4.3%, last increase was 3/6/2013.

Westar Energy (NYSE:WR) - Recommended then and now. Price is $32.32, yield is 4.2%, last increase was 3/7/2013.

Spectra Energy (NYSE:SE) - Originally bypassed due to low yield, now recommended. Price is $29.48, yield is 4.1%, last increase was 11/7/2012, which was a 9% bump.

Vectren (NYSE:VVC) - Originally bypassed because the payout ratio was too high, it is now within tolerance. Price is $35.11, yield is 4.0%, last increase was 11/13/2012.

Consolidated Edison (NYSE:ED) - Was in the group originally bypassed due to low yield, then reconsidered, and then recommended. I thought the price was too high then, but it is even higher now, at $59.09. Still, with yield at 4.1%, and a recent increase on 2/11/2013, ED is a viable candidate.

Southern Company (NYSE:SO) - Also was in the group originally bypassed due to low yield, then reconsidered, and then recommended. Price now is $45.66, yield is 4.3%, last increase was 5/3/2012.

Scana (NYSE:SCG) - This is the stock I meant to recommend that I somehow excluded in my summarizing comments in my earlier article. SCG still passes all my tests with ease, and is thus recommended. Price is $49.67, yield is 4.1%, last increase was 3/7/2013.

Utility Stocks I Still Recommend, Even Though Yield is Less Than 4.0%.

Piedmont Natural Gas (NYSE:PNY) - Originally dropped because the yield was less than 4.0%, I have relaxed that rule a bit so as to not miss a quality firm. Price today is $32.99, yield is 3.7%, and the last increase was on 3/21/13.

Xcel Energy (NYSE:XEL) - Same situation as PNY. Price today is $28.67, yield is 3.7%, date of last increase was 6/19/2012.

NextEra Energy (NYSE:NEE) - Same situation as SO, above. NEE is viewed by many as a top-performing utility, and the price of $76.17 reflects that sentiment. The yield is 3.5%, and the last increase was on 2/27/2013. Even though the yield is not what I would prefer, it is close enough to prevent this stellar performer from being discarded.

Alliant Energy (NYSE:LNT) - Same situation as NEE, above. Price is $49.16, yield is 3.8%, last increase was on 1/29/2013. I see no reason to let .2% less yield than my preferred level cause a top utility to be missed.

DTE Energy (NYSE:DTE) - This stock was one of the "finalists" from my earlier article that I did not recommend. Perhaps I was just biased against the Michigan economy. I cannot see why DTE should not be recommended, although perhaps not as enthusiastically as the others. Current price is $66.28, yield is 3.7%, and the last increase was on 2/26/2013.

Finalists Not Recommended After Detailed Review.

Integrys Energy (NYSE:TEG) - Originally excluded because the payout ratio was too high, TEG now passes on that score. While the utility passes most of the evaluation criteria handily, the dividend has not been increased since 2/25/2009, extending the drought to four years and counting. Based on the lessons learned, that disqualifies TEG from being recommended.

AGL Resources (NYSE:GAS) - Originally excluded because the payout ratio was too high, that shortcoming has been remedied. GAS was a close call, but there are two issues that cause me to take a pass; the debt level is a bit higher than the average, and the dividend rate was a bit erratic in 2012. Specifically, after a quarterly rate of $0.45 had been in effect for some time, a special dividend of $0.099 was paid, then the dividend was cut to $0.361 for one cycle, then the dividend was raised to $0.46 for three payments, then just raised again to $0.47, the current rate. Even though the changes have been mostly positive, I'm unnerved by the erratic nature of the changes, and I'm not sure what I can count on going forward with GAS.

Duke Energy (NYSE:DUK) - This monster-sized utility has pretty good numbers all the way around, but I passed on it originally because of the pending mega-merger with Progress Energy (PGN). The merger did occur, as did a 1:3 reverse split for DUK shareholders. The dividend rate was adjusted accordingly, so DUK income investors have no cause to complain. Two considerations give me pause, however; a management change immediately after the merger that can only be described as a debacle, and that may have soured relations with regulators, and the still significant challenges remaining to fully integrate the firms following the merger. I would prefer to wait and see how everything settles out before going in on DUK.

Dominion Resources (NYSE:D) - Originally one of the 10 stocks reconsidered after initially bypassing because of low yield, D was subsequently rejected because the payout ratio was right at the maximum. The current numbers are skewed by a substantial 4th Quarter 2012 impairment charge, which caused anemic 2012 full year results, which in turn leads to a PE in excess of 100 and a payout ratio of 373%. Even if you consider the impairment as a one-off event, and that the earnings going forward support the dividend, which could be deduced from the fact that it was increased on 2/26/2013, the debt levels are higher than GAS, above, and thus I see no reason to give D a pass.

All four of the preceding firms made it to the "finals" because they have many positives, and bear watching going forward; I just do not see any reason to jump in at this time, with better alternatives available.

Evaluation Tables For The 17 Stocks Subjected To A Detailed Review.

Recap For Remaining Stocks, Per Original Article, and Also Per Re-Review.

Edison International (NYSE:EIX) - Originally bypassed because the yield was too low. At 2.7% today, it is still too low to consider further.

Nstar (NYSE:NST) - No longer available, acquired by NorthEast Utilities (NU) on 4/10/2012.

NiSource (NYSE:NI) - Originally bypassed because the yield was too low. At 3.4% today, it is still too low to consider further.

Pepco Holdings (NYSE:POM) - Originally bypassed because the payout ratio was too high. Although improved, it is still too high.

Hawaiian Electric Industries (NYSE:HE) - Same situation as POM, above.

First Energy (NYSE:FE) - Same situation as POM and HE, above.

Progress Energy (PGN) - No longer available, acquired by Duke Energy on 7/2/2012.

Pinnacle West (NYSE:PNW) - Originally bypassed because of a static dividend, now skipped because of a low yield. Even with the first increase in six years occurring on 10/31/2012, the price has increased even more, causing the yield to fall below 4%. PNW may be worth keeping in mind if the increases keep coming, but for now, I would hold off.

Ameren (NYSE:AEE) - Originally bypassed because of a dividend cut in 2009. With a loss reported for 2012, I can see no reason to consider AEE further.

Sempra Energy (NYSE:SRE) - Originally bypassed because of payout ratio. With a huge price increase outstripping a dividend increase, the yield is now too low to consider SRE further.

CenterPoint Energy (NYSE:CNP) - Debt too high, then and now.

PG&E (NYSE:PCG) - Payout ratio too high, then and now.

Great Plains Energy (NYSE:GXP) - Originally bypassed because of a dividend cut in 2009. With a yield today below 4%, I see no reason to consider GXP further.

CMS Energy (NYSE:CMS) - Debt too high, then and now.

Exelon and Entergy - Recommended with reservations last time, neither is recommended now. See opening comments on lessons learned for specifics.

PPL Corp (NYSE:PPL) - Debt too high, then and now.

TECO Energy (NYSE:TE) - Originally bypassed because debt was too high, now bypassed because payout ratio is too high.

Atmos Energy (NYSE:ATO) - Was not recommended last time, although upon reflection I cannot give a good reason why. This time around, with a 36% gain in the price far outstripping a 1.4% gain in the dividend, I can give a reason to take a pass; the yield, at 3.3%, is too low.

Final Thoughts.

Income investors in stocks today are faced with a dilemma - either buy now at prices that are higher than desirable, or wait for better prices during a market pull-back, and perhaps not be able to get in for many months, maybe even years. Today's high price may be tomorrow's reasonable price, which should have been taken advantage of instead of passing. My own approach, if no attractive entry point comes available on a stock I want to buy, is to acquire a small number of shares within a couple of weeks of an ex-dividend date, and then await an opportunity to average down. If three months later, no such opportunity has arisen, repeat the process, and continue on until all shares desired are in the account. Or alternatively, stop short of a full position, and wait it out from that point on until an average-down opportunity arises. Another approach, championed by Josh Peters of the Morningstar Dividend Investor, my favorite advisory newsletter, is to remain fully invested at all times; when cash builds up sufficiently in the account such that there is enough available to justify paying a commission, allocate the funds to the best buy opportunity available at that point. Each investor will have to come up with his/her own acquisition approach. My only admonition is to define the approach which suits your personality, then stick with it.

Disclosure: I am long AEP, PEG, WR, SE, EXC. 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.

Additional disclosure: I am a subscriber to the Morningstar Dividend Investor, and I find the newsletter to very informative. Other than that, I have no relationship with the newsletter.