Utility Preferred Stocks: My Top Picks For Income

by: Rubicon Associates

As I am a capital structure investor (finding the best value within the capital structure of a company/sector), I often take a look at certain levels of the capital structure within sectors. I recently looked at the preferred stock slice of the capital structure within the utility sector.

Below is a list (a representative sample of the universe) of utility preferred stocks I looked at comprised of NextEra (NYSE:NEE) Southern Co (NYSE:SO), Constellation (NYSE:CEG), Progress (PGN), Alliant (NYSE:LNT), PG&E (NYSE:PCG), Exelon (NYSE:EXC) and Edison (NYSE:EIX) :

Source: QuoteMedia

The list (again, a sample from a pretty homogenous universe) leads me to a couple conclusions:

As the majority of issues are currently callable, the yield to call is going to be negative (YTC is an annualized yield), so an investor getting into the market now can expect a negative yield should the issue get called. In the calculation of YTC I assumed a 60 day period before call.

Some of the issues with the greatest equity yield differential are also the highest coupon issues (CEG and LNT) which increases the probability of a call (although, to be fair, they haven't called them yet and we have been in a low rate environment for some time) and the need to redeploy capital elsewhere.

Of the list, my top choice for income is the Progress Energy 7.10% (FPC-A) preferreds as they are attractive from an absolute yeild and equity yield differential (6.89% and 2.35% respectively), while having a lower negative YTC (-1.08%). The issue is a mid-triple B issue and the utility has a diversified customer base (as part of progress energy - this was a Florida Power issue). Be aware that DUK and PGN are getting married. PGN has recently announced a settlement with consumer advoctes in Florida that should help smooth things out from a regulatory perspoective (their PUC hasn't been that friendly in the last few years).

My second choice is the NextEra 5.88% (FGC) preferreds as the equity yield differential is 2.72% and the coupon is not so high as to have a high probability of being called (YTC is -10.6%). The company is also highly rated and has a relatively consevative financial profile, serves a stable market and has the whole "clean energy" generation winds at their back.

Bottom line here is that utility equities, which were once the backbone of an income investor's portfolio, have lagged in the past year or so and the capital losses have easily offset the common dividend yields - yes, both have to be considered even for income portfolios. One alternative is buying the preferred stock of these companies which will give you lower volatility and greater income. Looking at a combination of all factors (yield, equity yield differential and yield to call) have led me to my two top picks.

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