Over the past five years, American Electric Power Co. Inc. (AEP) — the $33.1 billion Ohio-base...
Conrad's Best Buys in Utilities
07/17/2015 10:00 am EST
Investors have sold utilities in recent months due in part to fears of interest rate hikes; utility expert Roger Conrad, editor of Conrad's Utility Investor, sees this as a buying opportunity, particularly for this pair of high quality utility outfits.
Steven Halpern: Joining us today is Roger Conrad, leading utility sector expert and editor of Conrad’s Utility Investor. How are you doing today, Roger?
Roger Conrad: Great, Steve. Thanks for having me on.
Steven Halpern: Well, thank you for joining us. You point out in your latest research that investors have sold utility stocks en masse in large part due to fears of interest rate hikes. Are investors making a mistake here by selling?
Roger Conrad: I think, you know, I think so, particularly if they’re longer-term positions that investors have held for a number of years. I mean, we go through these interest rate—and other related selling—and then, earlier this year, of course, it was buying, but this type of volatility, it really has nothing to do with your longer-term returns in stocks like these.
These are companies that have shown their ability to come back from even the worst disasters. They grow consistently as they invest in their network, so while sometimes they stumble, at this point actually, they’re in probably the strongest financial state they’ve been in in many years, so yeah, I think people have made a mistake.
I think it is an opportunity, though, for investors to pick up a lot of these stocks at much lower prices than we’ve seen in quite some time.
Steven Halpern: Very surprisingly, you point out that, historically, utility stocks haven’t really shown a very strong correlation to movements in interest rates. I think most of our listeners would be very surprised to hear that. Could you explain that in a little more detail?
Roger Conrad: Well, basically, what I did is I went back—and not only for utilities but also for other dividend paying stocks such as real estate investment trusts, master limited partnerships, big telecom—and I looked at their annual returns compared to changes in benchmark interest rates.
I used the 10-year Treasury note yield as that benchmark rate—which is commonly compared to these stocks—and what I found was, in fact, just as many years when utilities and other dividend paying stocks rallied when interest rates had risen as rallies when interest rates had fallen.
In fact, the worst year for utility stocks—any kind of dividend paying stock—in recent memory, and this is really going back to the 80s and earlier, the worst year was 2008 and that was the year when benchmark rates fell in half.
So, yes, we do have selling and buying with the interest rates, with that kind of sentiment that takes place over a period of months—weeks or months—but when you look at the annual returns, and I think, again, that’s what is important for investors in utility stocks, they want to own them for a long period of time.
They want to collect as dividends. The annual returns really show no correlation with what’s happened with interest rates so that’s something—as you point out—that’s something that, in fact, that a lot of people aren’t aware of. But you can definitely use that to your advantage as well.
Steven Halpern: So, let’s take the opportunity to walk through a couple of your favorite ideas in this sector and one stock that you’re bullish on is the Michigan-based utility CMS Energy (CMS), which, as early as 2003, was on the verge of bankruptcy. What’s the story with the company now?
Roger Conrad: Well, this is the company that went all in, I guess, on the Enron model back in the 1990s. They set up energy trading in Houston that was sort of out of the—I guess you could say—knowledge set of the upper management and they paid the price and nearly went bankrupt about 12 years ago.
But since then, they’ve really tried to get back to business, get back to just running a regulated utility. They’ve cut operating risk. They’ve repaired relations of regulators.
They’ve systematically reduced debt and what you have now is just a really strong company that has a pretty good plan in place to grow dividends at an upper single digit rate, and which, is very good for stock price gains over time and with very little risk.
They’re keeping their rates below national averages and keeping the rate increases down, by virtue of cutting costs, but they’re also investing in network which increases their rate base, increases their earnings base, and their ability to ramp those dividends up.
So, we took a look at this one last month and it had really come off pretty heavily as a part of the ETFs. This is a larger utility and people selling it for interest rate reasons—and we’ve already got a fairly nice gain in it from our June issue of Conrad’s Utility Investor—and we think there’s more upside here.
Again, it’s just a very steady company. It’s also a pretty good example of the kind of values that are emerging in this market where people are so worried about the macro factors, so worried about interest rates—and again, these are fairly ephemeral factors—and they are willing to dump even the strongest companies there.
So, I think we’re going to see a lot more of these, of this type of opportunity to pick up really good companies that have been expensive for a long time.
CMS was almost at $40 earlier this year, a price I thought was well out of the range of what anybody should pay for it. But now it’s on the come again, and after selling off and again, a great company selling at a good price. That’s a pretty good formula for making money in any market.
Steven Halpern: Now, another company in that situation is Dominion Resources (D) where you say selling pressure might be giving longer-term investors a golden opportunity. Could you expand on that?
Roger Conrad: Well, this is a company that not only controls and operates one of the strongest electric utilities in the country in the state of Virginia, a state where power demand is growing, where they have great relations with the regulators.
They’re taking advantage of solar power opportunities so they’re just really out in front of everything, and the more they spend, they increase their rate base, increase earnings.
But not only do they have that, but they also have a growing midstream energy operation, in other words, pipelines, gathering systems, storage systems, and in fact, a liquefied natural gas export facility under construction off the Maryland coast.
And the gas that they have access to is about the cheapest in the world. It’s the Marcellus Shale, the Utica Shale, very cheap, also lots of natural gas liquids there and a lot of opportunity for exports as well as for moving that gas and so forth to regions like New England where they’re transitioning out of coal fired power plants and looking to clear the air, and gas, of course, is a lot cleaner burning than coal or oil.
It also emits less than half the carbon dioxide emissions, which is important in a lot of those states, so they really have a huge opportunity to be more or less the toll collector as all this gas moves out of this really low cost area, and not only into New England and regions like that, but also around the world through the export facilities, so there’s a lot of upside there.
They launched a massive limited partnership Dominion Midstream Partners (DM) that they pretty much control and collect the lion's share of the economics from and they are going to drop down a lot of assets from the parent to that as well.
So that’s going to help also rev up dividend growth, and I think what you have here, again, is just a really solid outfit that they invest in these really high percentage areas with a lot of upside and we’re going to have upper single digit dividend growth.
The yield right now is pretty close to 4%, and again, that’s a pretty good formula for any market. The stock could get knocked around here like all stocks, but again, we’re well off the high already and it’s a pretty good value proposition, I think.
Steven Halpern: So, overall, is it fair to say that given market pessimism that this may really be an opportunity for long-term investors to buy long-term positions in high quality utilities such as CMS and Dominion?
Roger Conrad: Yes, I really agree with that. I think you want to be selective, but I don’t think there’s anything wrong, also, with investing in increments, so buy a third of what you want to get now and buy another third in a month and then another third in a month from now, but so, I don’t think anybody is in any big hurry to get in.
We’re in the seventh year of a bull market after all, but again, looking at these things just straight up values, looking at the companies, looking at the quality of these companies, their ability to weather almost anything that comes down the pike. They certainly did weather 2008 better than any other industry.
I think you do have an opportunity if you watch these prices and buy when everyone else is selling. It’s just simple contrary investing, and I think, if you get a group like this that’s in the peak of the health and has all these opportunities, I think going forward, you really have a major opportunity to really lock down some strong, long-term returns going forward.
Steven Halpern: Again, our guest is Roger Conrad of Conrad’s Utility Investor. Thank you so much for your insights today.
Roger Conrad: Thanks, Steve.
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