Over the past five years, American Electric Power Co. Inc. (AEP) — the $33.1 billion Ohio-base...
Utility Trio for Long-Term Gains
09/16/2015 10:00 am EST
Despite the underperformance of utility stocks this year, sector expert Roger Conrad, editor of Conrad's Utility Investor, sees opportunity for long-term investors. Here, he outlines the bullish case for the industry and highlights a trio of favorite utility stocks for long-term, conservative investors.
Steven Halpern: Our guest today is Roger Conrad, the advisory industry’s top authority on utility stocks and editor of Conrad’s Utility Investor. How are you doing today, Roger?
Roger Conrad: Great, Steve. Thanks for having me.
Steven Halpern: Well, thanks for joining us. Historically, utilities have been a safe haven in times of uncertainty, but rather than outperform, the sector has been weak along with other sectors this year. What’s behind this trend of underperformance?
Roger Conrad: Well, I think if you want to look at one particular factor, it would have to be uncertainty about what the Federal Reserve might do with interest rates, and of course, they have been talking about raising rates for, I guess, a couple of years now, and I guess, thwarted pretty much every time they have started, but there is a perception out there that it’s going to be negative for utilities as well as most dividend-paying stocks.
So, I think that’s been a major factor. I think they have also gotten caught up in the overall selling in the stock market as people tried to de-risk, but I think that the Fed is actually probably one of the major factors to look at in terms of driving the short-term trading.
Steven Halpern: Would you think those concerns are already factored into prices of utilities?
Roger Conrad: I think so. You know, the best, you know, the market history doesn’t always totally repeat but it often rhymes, and if you look at the last tightening cycle, we saw similar action before the Fed started raising interest rates.
In other words, people got very concerned—and this was back in 2004—but when the Fed started raising rates—and that was a cycle that began in June of 2004 and ended in June 2006 and raised the Fed funds rate from 1% to 5.24%—utilities actually did extremely well.
They were up about, returned about 60% over that two-year period, which is one of the better two-year runs for that group, or really, for any group looking back over, well really, since World War II.
So, I guess you could say buy on room or sell on news to some extent, but once the Fed actually started raising rates, the group started rallying, and if you look at that rally that utilities had that began in late 2002 and ended in early 2008, that was a good chunk of the returns were made during that period where the Fed was raising rates.
So, I think we will see a reversal; you know, obviously what happens in the broad market is going to be important, because if everything is going down, nothing is going up, but if history repeats itself to some extent with the Fed tightening cycle, I think we could see some really unexpected gains in the number of stocks.
Steven Halpern: So while investors are using short-term uncertainty to sell holdings, your view remains that long-term investors should use this weakness to add to established positions. So, turning to the very long-term, you remain confident that the utility sector should be a major part of a conservative investor’s holdings?
Roger Conrad: I think so; you know, it’s just as essential, in fact, probably even more essential than ever to a functioning society. You know, the group did very well in 2008, obviously the stocks sold off, but the companies actually continued to raise dividends over that time.
And the reason is just because we need electricity and that’s more true now, I think, than it’s been any time in history, really, and one of the things that’s exciting for the group is that there actually are a lot more ways that we’re using electricity now and companies are taking advantage.
I think one area that people have been very concerned about, which has been adoption of solar energy in particular, but companies have really been able to take advantage and actually use that to raise earnings, so that’s an untold story too that makes me very bullish on the group.
Steven Halpern: So, for those looking to take advantage of opportunities now, could you walk us through a few investment ideas that you believe should be part of a long-term investor’s portfolio?
Roger Conrad: You know, I like the best-in-class of any sector, you know, not just utilities but others and what I mean are companies that are in the best position to take advantage of what’s happening in the market now.
They have strong balance sheets and they are well-positioned for the future and there are three utilities I have been taking a look at and they have been—at various times over the past several years—really, too pricy, I think, to buy.
But one of the nice things about—or the silver linings, rather—about the sell-off that we’ve seen since January of this year is that some of these have been coming down, so three of them, just to chew on, Dominion Resources (D), that’s based in Virginia, Sempra Energy (SE), which is based in Southern California, and NextEra Energy (NEE) which is actually based in Southern Florida, down your way.
All three of these companies are very strong in terms of the regulated utilities, good relations with the regulators. It gives them a good base. They have very good balance sheets because of that and then they are also investing in the growth areas of the business, renewable energy as well as in natural gas and we’ve seen a lot of companies make a major move to gas.
It’s been an easy way to comply with environmental regulations at the same time as cutting costs and this has been a huge investment opportunity that all three of these companies are involved in as regulated utilities, but also, as in other parts of their enterprises.
And the result is a really nice package of growing earnings and growing dividends and there’s a lot of transparency for—or visibility for—going forward, so again, the sell-off in the market is giving us an opportunity to buy companies like these and I think these are excellent stocks to lock in for the long-term.
Steven Halpern: So you and I are speaking just before the Fed's September meeting where—from what you’re explaining—if there is a sell-off sparked by a move up in rates, would you consider that an opportunity for investors with a long-term focus to step in?
Roger Conrad: I definitely think that that would be a great strategy here, you know and it’s sort of unknown what the Fed is going to do. It’s an unknown how the market is going to react to it initially, but what we do know is in 2004 to 2006, utilities did very well over that time.
We also know that there are a number of companies here and the three I’ve named for you—Dominion, Sempra, and NextEra—are very well positioned for long-term business trends.
I think there is a very good expectation investors can have for 10% to 15% total returns every year just compounding, and if you’re reinvesting your dividends as I do I think, it’s a tremendous way to build wealth and take advantage of short-term pullback, based on fear of the Fed and also non-differentiation between the companies.
Steven Halpern: Again, our guest is Roger Conrad of Conrad's Utility Investor. Thank you so much for taking the time today.
Roger Conrad: Thanks, Steve.
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