Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Low-Voltage Utilities

Stocks March 5, 2009, 5:00PM EST text size: TT
Low-Voltage Utilities After years of deregulation, many utility stocks are on shaky ground

By Aaron Pressman

Shares of utility companies, once considered the safest of defensive equity investments, have taken a pounding. The Utilities Select Sector SPDR exchange-traded fund (XLU), which tracks the prices of 33 companies, has lost 34% over the past six months—better than the 45% drop in the Standard & Poor's 500-stock index, but hardly the kind of stability investors expected. Making matters worse, some utilities have slashed their dividends. Constellation Energy Group (CEG) was among the latest to cut, reducing its quarterly dividend by 50%, to 96 cents a share on Feb. 18.

The turmoil follows years of deregulation, which brought competition into the once-monopolistic sector. Customers of unregulated utilities can shop among them, forcing utilities to cut prices, which squeezes profit margins. Regulated utilities, which petition state commissions for rate hikes, have a more stable customer base. And they can persuade their overseers to let them raise rates even in a weak economy to pay for new projects—with a healthy profit margin built in. In December, California's Public Utilities Commission approved a $2 billion, 123-mile electric transmission line project for San Diego Gas & Electric, a unit of Sempra Energy (SRE), that provides an 11.5% return for the company.

Those distinctions will give an edge to regulated utilities such as Sempra and Dominion Resources (D), a power provider in Virginia and North Carolina, analysts say. Sempra and Dominion, whose share prices dropped with the sector over the past six months, "have gotten way too cheap," says Standard & Poor's (MHP) analyst Christopher Muir. "Earnings may be hurt a little by the economic downturn, but for the most part they're safe." Both just raised their dividends, a sign of financial strength, Muir adds.

Still, many weaker utilities are likely to cut dividends in the coming months, according to Sanford C. Bernstein & Co. analyst Hugh Wynne. He and his team pored over capital spending plans and cash-flow models to rank 47 utilities by the likelihood of a reduction. Sempra, MDU Resources Group (MDU), and Exelon (EXC) were judged least at risk; Constellation was at the top of the list before its recent dividend cut; and now UniSource Energy (UNS) and Empire District Electric (EDE) (table) appear most at risk. (Empire declined to comment. A spokesman for UniSource says it raised its dividend 21% this year, and the board has signaled that it intends "to keep increasing for the next few years.")

Investors would also do well to avoid the least regulated segment of the industry—independent power producers. The group, which includes Dynegy (DYN) and Reliant Energy (RRI), mainly own power plants that produce electricity but have no captive customer base. Industrial power demand is falling rapidly, and some utilities have also been hurt by the plunge in natural gas prices, which makes the price of their coal-fueled power less attractive.

The outlook for at least the next six months is weak for independents, says Citigroup (C) analyst Brian Chin. The projected price for a megawatt of power during peak daytime hours sank from $100 last summer to about $45 in February and is still falling. "When the economy is booming, these are the stocks that zoom," he says. "But when the economy is weak, they get really slammed."

Pressman is a correspondent in BusinessWeek's Boston bureau.