Best Bets Among Utility Stocks

09/06/2013 10:00 am EST

Focus: UTILITIES

Roger Conrad

Founder and Chief Editor, Capitalist Times

Utility sector specialist Roger Conrad has launched a new advisory letter and shares some of his new top stock picks from his conservative and aggressive model portfolios.

Steve Halpern: We're here today with Roger Conrad, Editor of the just launched newsletter Conrad's Utility Investor. How are you doing, Roger?

Roger Conrad: Pretty good. How are you?

Steve Halpern: Very good. You've been following the utility sector for nearly 30 years now, but your latest newsletter venture is only a few weeks old. Can you tell us a little about your new service?

Roger Conrad: Well, what we're trying to do is based on the same philosophy that I've had over the years, but we're trying to make a few new improvements that I think will be interesting for investors. We have a DRIPs Portfolio and, really, we're talking about three different objectives here.

One is compounding wealth over time and that's obviously accomplished with the DRIPs. I've had quite a bit of personal success with that, as well as in the letter. We have a conservative income portfolio and our approach there is, basically, people who are living off their investments, and trying to make the most of what's, really a different kind of environment, than certainly when I started the business.

Back when I started writing about utilities, back in the 1980s, for example, the retail investor pretty much dominated that space, but now we're seeing, particularly with the rise in popularity of income investments, a lot more institutional participation.

The result has been a lot more volatility in the group, but more opportunity to buy low and sell high. That's our objective there with, of course, the great companies in the sector.

Then also, I have an aggressive income portfolio, and another consequence of change in sector, with deregulation, which, of course, has changed the industry a lot, and companies no longer really move in lock step, but they really have to look at individual business models.

But one of the consequences there is, we've seen some tremendous opportunities appear in the unloved stocks of the group. That's what we try to do there, to take advantage of good opportunities.

We're more or less based around those things. I have a coverage universe of about 200 names, and that's been a staple of mine over the years, is really trying to take a bottoms-up approach.

I come up with theories, and themes, rather, and trends, by looking at what's going on on the ground with these individual companies, and that's, I think, one way that we identify opportunities. It's one way that we identify the dangers that are inherent in these sectors, and that's really how we make good returns over the long-term.

Steve Halpern: Under the overall umbrella of utilities, you cover all, what you call, essential services such as electricity, heating, communications, water, and even pipelines. Among these areas are there any sectors that stand out as offering the best current value?

Roger Conrad: Well, I think right now what we're seeing in the markets is a lot of worry about what happens at the end of QE3, or quantitative easing, that the Federal Reserve has been undertaking, really, since the crash in 2008.

The worry is we're going to see a real backup in interest rates, and that dividend paying stocks, that we see a big correction there.

We've heard a lot about interest rate sensitivity. I think a lot of people are putting out a message that you want to sell your dividend paying stocks because interest rates are rising and they're really just bonds.

But, you know, if you look back at the performance, the actual correlation of dividend paying stocks with the bond market, you have to stretch the imagination really to see much of anything.

Rather, these stocks follow the stock market. In fact, if you look back, 2008, when the benchmark 10-year Treasury bond yield fell from well over 5% to less than 2%, and of course lower rates, there was tremendous buying. It was really the mother of all rallies for bonds.

If you looked at what happened with the dividend paying stocks like utilities, if they were real interest rate sensitive, you should have had really a tremendous rally then. Instead, they fell along with everything else. Maybe not quite so bad as the S&P 500, but certainly falling along with the rest of the stock market.

The more people talk about the so-called interest rate sensitivity and correlation, and the more they talk themselves out of owning good positions, and just basically steady utility stocks, the better values that we're seeing.

We've had a four and a half year bull market and stock prices really running up. I was really having a lot of trouble finding values back last spring. That's no longer the case today. We're seeing more and more companies come down and the stock prices come down.

It's a great opportunity to pick those up, so I think the stocks that are considered to be the most interest rate sensitive are actually becoming quite impressive in values.

Again, you're just basically taking advantage of a lot of investors' misconception that these stocks are somehow bond substitutes, when the record is crystal clear that they follow the stock market.

Steve Halpern: As you mentioned, you have both an aggressive model portfolio and a conservative portfolio. Let's start with the aggressive one. Obviously, aggressive stocks are going to entail more risk for investors, but would you be kind enough to share a name or two that you like that fall under your aggressive portfolio.

Roger Conrad: Well, one that I read about actually in the very first issue of Conrad's Utility Investor is a company called Telefonica (TEF). This one is a company that has had a pretty tough several years.

Europe has obviously been a very tough place to operate, particularly Spain, which is its old home country. Still they're sourcing about 30% of revenue, but this company has managed to navigate through a pretty tough environment.

They do have a lot of very rapidly growing operations in Latin America and they've been making very good progress of reducing debt, which the market really has demanded of them.

I think what you have here is pretty much a quintessential aggressive portfolio type of stock, where you have a lot of bad feelings, a lot of low sentiment, a very low bar of expectations set for a company that has a very strong long-term track record and a number of catalysts for future growth.

As long as they execute, and they have, then you're going to get that higher valuation, so as an investor it's a really good opportunity to pick up some very strong capital gains in a company with a lot of staying power.

Again, they're an essential service company. People are using communication services really no matter what the economy is, so they have a very large degree of revenue stability that other industries simply don't have.

Steve Halpern: In your conservative portfolio, you focus on what you call, tried and true stocks, that you expect to deliver reliable returns through both bull and bear markets. Would you share an example of one of those?

Roger Conrad: Sure. I mean one of the companies I think you'd be very hard pressed to find a peer to, in terms of just sheer resilience, would be Southern Company (SO).

It's an electric utility. It services Georgia, Alabama, Mississippi, Florida states. They tend to have a pretty strong pro-business bent and they're also states that are growing partly for that reason.

This company has just been able to invest in its network of power lines, power plants, and so forth; pass those costs through in a cooperative way with supportive regulators in those states, and they still have very, very low rates, because they've been able to do this in an efficient way and utilize long-term planning.

Here you have this company with a tremendous formula for growth. It's actually down over the past several months to a large extent because of this interest rate sensitive thesis, and the way that people sell particularly larger stocks like that, that are owned a lot by institutions, encountering a lot of selling just on that basis.

Again, I think people are going to wake up and discover that they've sold at a bad time, a company that yields pretty close to 5% and is growing its dividend at an annual rate of 3% to 5% a year. That's a real nice formula for long-term growth. I actually have Southern Company in my DRIPs Portfolio as well.

It's a great wealth compounder even though it's a very conservative company, even though there are not a whole lot of ups and downs. If you're reinvesting those dividends, it's going to build wealth for you in a way that will be quite surprising, if you look down the road and see what happens just from simply, again, reinvesting dividends.

Steve Halpern: Well congratulations on the launch of the new Conrad's Utility Investor and thanks for joining us today.

Roger Conrad: Thanks Steve. Thanks for having me.

Subscribe to Conrad's Utility Investor here...

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