Charged Up Over Utilities

10/15/2004 12:00 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

"Seasonality is a major reason to be bullish on utilities near term; utilities generally do very well in the last quarter of the year," says Roger Conrad, a leading expert on the utility sector. Here, he discusses his outlook and some current favorites.

"In 29 of the last 35 years, utility stocks have been up. For those 29 years, the average gain has been about 7.5% in the Dow Utility average. So seasonality is working pretty hard in favor of utilities. Falling interest rates are another green light for utility stocks. The ten-year Treasury note yield has fallen to barely 4% from nearly 5% this spring. And there’s more to come. Though typically inflationary, rising oil prices have actually slowed the economy and suppressed inflation. Meanwhile, a tighter Fed and record deficits have halted Washington-fueled stimuli, keeping growth slow and interest rates low. A third reason to favor utilities near term is election-year uncertainty, which increases the attraction of safe havens. The Dow utilities have scored fourth quarter gains in all eight Presidential election years since 1969. Gains were slightly greater when Democrats were victorious, a good sign the pattern will hold regardless of the results of the election.

"Looking out to 2005, we'd note that potential turmoil, volatile energy prices and the threat of economic/market shocks are three reasons why even the strongest utilities could get a bit cheaper next year—and why you shouldn’t chase high flyers. Rather than chase them, wait for lower prices that should reappear in the traditionally weak early months of the new year, and buy the still numerous stocks trading below buy prices. But for now, those interested in a near-term trade should check out the exchange traded funds. My favorite is the highly concentrated and therefore more volatile Utility HOLDRS Trust (UTH ASE), which yields 3.5%. Buy the Utility HOLDRS up to 87 as a bet on utes to score fourth-quarter gains.

"FPL Group (FPL NYSE) is a very conservative utility based in Florida. They just went through hurricanes, so there is a little uncertainty regarding recompensation for damage. But they are the largest wind producer in the US. Wind power has changed a lot. They are also involved in nuclear power. This is really a cash cow business. In the old days, nuclear power plants were heavily-indebted and they were big white elephants tied around company’s necks. But since deregulation, they were sold to other companies like FPL at very cheap prices. And the variable costs of running these plants are very low compared to gas and oil. I’d also note that FPL is the best-funded company in the sector regarding its pension plan. The utility holds nearly twice the assets needed to meet future obligations and uses the industry’s most conservative estimate of returns for its calculations. That’s another great reason to pick up FPL any time it trades under 65.

"China’s economy continues to grow at a rate of nearly 10% a year, despite government attempts to slow it down. That spells robust demand for electricity and big profits for the country’s premier power play: CLP HOLDINGS (CLPHY Other OTC). The firm's core is Hong Kong, the global financial center that still accounts for about 80% of its earnings. Hong Kong shows no sign of slowing down or abandoning their pro-business ethos. That should ensure solid cash flows and dividends for CLP past its scheduled expiration in 2008. CLP’s Hong Kong base is an ideal launching pad for expansion elsewhere in Asia. In addition to owning half a dozen power plants in mainland China, the company also has lucrative projects in Australia, India, Taiwan, and Thailand, which contribute a rising stream of earnings. For CLP, the best is yet to come. Buy up to 6.

"High-dividend yields are eye-catching, but reliable dividend growth is the secret to great long-term total returns. And few investments have the dividend power of Energy Transfer Partners (ETP NYSE). Forged from the January 20 merger of Heritage Propane Partners and La Grange Energy LP, Energy Transfer derives roughly two-thirds of its income from natural gas midstream assets in the energy patch of Texas, Louisiana and Oklahoma. The balance is from selling propane to a growing base of 650,000 customers in 32 states. In the first nine months of fiscal 2004 (end May 31), that mix produced cash flow growth of 17%. Finances are solid, with distributable cash flow covering the current dividend by a solid margin. Expense controls and acquisitions should boost cash flows nearly 20% in the next 12 months. Like all limited partnerships, Energy Transfer mails a K-1 in late February that must be filed with your taxes. And in any case, the growth and high yield—much should be a tax-deferred return of capital—are well worth this extra step. Buy up to 45."

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