Good Times Ahead for This Utility

02/16/2010 1:30 pm EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad, editor of Utility Forecaster and associate editor of Personal Finance, finds a utility that will grow strongly in a very favorable regulatory environment.

Rising investment equals higher earnings, dividends, and share prices: That’s basically the case for high-quality electric utility stocks. And it’s proven its worth to investors since the power industry’s origins in the late 19th century.

Except in times of severe stress, US demand for power has risen steadily.  During the past decade alone, rapid penetration of sophisticated electronics, from flat- screen televisions and gaming devices to cellular phones and laptop computers, has pushed electricity’s share of total energy used to more than 40%—and it’s headed a lot higher.

Meeting electricity demand will require trillions of dollars of new investment, in addition to what’s needed to meet conservation and efficiency goals through the various “Smart Grid” initiatives.

Trillions of dollars in infrastructure investment means power utilities will enjoy robust and reliably rising earnings, dividends, and share prices for many years to come—but only if they can earn a fair return.

The key is regulation. If the officials who set utility rates allow a reasonable rate of return, companies will enjoy a low cost of capital. Needed infrastructure will be built cheaply, quickly, and efficiently. Customer rates will rise, but much more slowly than inflation. Power company earnings, dividends, and share prices will rise.

Utilities in friendly states are set to prosper as never before. Others may be headed for ruin. It’s never been more important to sort reliable regulators from the rotten.

Over the next five years, Sempra Energy (NYSE: SRE) will spend $12 billion adding to its collection of low-risk power and gas distribution, pipeline, and energy storage assets.

That’s a powerful driver for dividend growth, which has already averaged more than 9% the past five years.

Formed by the merger of the parent of Southern California Gas and the parent of San Diego Gas & Electric in June 1998, Sempra serves 29 million customers globally, 20 million in California.

Under Governor Arnold Schwarzenegger, Golden State regulation has been first rate. But the company has also successfully navigated adverse market and political conditions.

Sempra divested most of its California generation assets when the state deregulated electricity in the 1990s. As a result, it has no potential problems from carbon dioxide regulation; most of its 2,600 megawatts (MW) are state-of-the-art gas-fired plants.

It also runs a 400-MW solar facility, is an equal partner with BP Wind Energy in a 200- MW wind plant in Indiana, and owns a liquid natural gas import facility in Mexico.

All of these assets produce steady cash flow, mostly under long-term contracts. Meanwhile, 2010 results will get a lift as Sempra gets a stronger partner for its low-risk commodity business, currently 51% owned by financially strapped Royal Bank of Scotland (NYSE: RBS).

With the stock off nearly 10% this year on uncertainty regarding the commodity business, buy Sempra Energy up to $55. (It closed just below $50 on Friday—Editor.)

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