Utility Dividends Look Pretty Safe

03/05/2009 12:00 pm EST

Focus: MARKETS

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad, editor of the Utility Forecaster, says dividends for most utility stocks should hold up better than in previous recessions.

Thanks to six years-plus of slashing operating risk and debt, utilities have been an island of strength in these troubled times, which have shaken icons in other industries to their cores. But even essential service companies have suffered some casualties in this bear market.

As we’ve seen with fourth-quarter earnings, some companies that had been doing well up until September 2008 did show signs of cracking in the face of the freezing of credit markets and the steepening decline in economic growth. The weakness even showed up in recession-resistant sectors, such as the utility industry.

After the crushing selloff of last fall, there’s certainly no shortage of high-yielding stocks for the picking. But the stress tests behind this bear market are arguably severe as ever, and the consequences of choosing a weakling that succumbs are dire.

This is hardly the first time, however, that essential service company dividends have come under fire.

Even in the worst years, the total number of dividend cuts has been infinitesimal relative to the 200-plus essential service companies I track. And I’ve double-counted companies that cut dividends more than once.

Two periods stand out as the worst of times. The aftermath of the post-Enron sector meltdown produced 27 cuts in 2002 and early 2003. The other is this bear market, which began in mid-2007 and has thus far seen more than 20 dividend cuts by [our] companies.

Regulated power, gas, and water utilities as businesses are in a place 180 degrees distant from where they were in 2002. When that relatively mild recession hit, companies had been piling on debt to build natural gas-fired power plants and expand energy trading operations. They couldn’t have been worse prepared for tighter credit conditions, slowing sales, plunging power plant values and, finally, the wave of scandals following the California power crisis and the collapse of Enron.

That near-death experience, however, inspired an unprecedented industrywide deleveraging. The 34% jump in utility bond issues in 2008 is a clear testament to the industry’s enduring financial strength in these tough times. So is the fact that yield spreads with US Treasuries have now shrunk to around 200 basis points from 500-plus just a couple of months ago.

The key is still to maintain a diversified and balanced portfolio of companies that are making it through this mess as businesses. That means searching carefully through your companies’ numbers every time they release earnings. It means being vigilant and disciplined about selling anything that falters. And it means being in position to weather market storms emotionally, possibly by having a good cash cushion.

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