A New Environment Means New Utilities

09/04/2012 10:45 am EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

Even with long-term investments like utilities, there are better times than others to add to your shares, swap weaker shares for stronger ones, or just buy into a rising ute at bargain prices, reports Roger Conrad of Personal Finance.

For most investors, utility stocks are more or less permanent holdings. Even companies that stumble eventually return to health by cutting operating risk and debt and repairing relations with regulators.

However, timing purchases and occasionally taking a profit can enhance returns. Today, that means scrutinizing the unregulated side.

Exelon’s (EXC) key weakness is that wholesale prices are tied to falling natural gas prices, a trend that has weighed on the company’s results and stock price. Fortunately, Exelon’s successful acquisition of Constellation Energy for $7.7 billion earlier this year reduced the impact of a feared “earnings cliff,” as Exelon’s selling price hedges come off.

That’s why we expect the stock’s projected earnings per share of $2.55 to $2.85 for 2012 to represent a bottom for the year, even though they’ll still comfortably cover the 5.5% dividend. Exelon is a buy up to $45.

Note: Exelon is a new Income Portfolio addition, replacing now-sold Washington REIT (WRE).

Atlantic Power (AT) derives all of its income from selling power into wholesale markets throughout North America. Fortunately, almost all capacity is locked up under long-term contracts. And thanks to last year’s merger with the former Capital Power, the firm has diversified its revenue streams.

Atlantic’s second-quarter cash flow rose 70% from the same quarter last year. The company also expects a fourth-quarter opening of a major wind plant in Oklahoma, anchored by a 20-year contract with OGE Energy (OGE).

Atlantic pays dividends from cash flows rather than EPS. That enables the company to dish out more aggressively, with a 90% to 97% payout ratio expected for full-year 2012 and a yield in excess of 8%.

Atlantic also owns the regulated Path 15 power line in California, while Exelon runs power distribution operations in Illinois, Maryland, and Pennsylvania. Both companies’ dividends held in 2008-2009, with Atlantic raising its payout in late 2011. Atlantic Power's American depositary receipt is a buy below $16.

NRG Energy (NRG) is a third unregulated power stock to consider. The company is attempting to acquire battered rival Genon Energy (GEN) in a deal that will make it by far America’s biggest producer of wholesale electricity, with a fleet of natural gas, coal, nuclear, and renewable plants with 47 gigawatts of capacity. That deal is expected to close in the first quarter of 2013.

In the meantime, NRG has initiated a quarterly dividend of 9 cents per share for the first time in its history. After doubling its cash flow from year-ago levels, NRG Energy covered this inaugural payout by an ample margin.

As with all wholesale power producers, NRG’s stock has suffered the past five years, losing more than half its value. But with well-run assets and a solid balance sheet, it’s poised for a reversal of fortunes. Buy NRG Energy up to $22.

Unregulated earnings mean these stocks are riskier than largely regulated Dominion (D), Southern (SO) and Xcel Energy (XEL). However, this risk is well reflected in their stock prices, making Exelon, Atlantic, and NRG excellent fresh horses for another utility stock run.

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Related Reading:

A Commercial REIT with a 9% Yield

Why Everyone Is Piling into Junk Bonds

Dividends May Be Our Saving Grace

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