Three Safe Utilities That May Beat the Market

09/28/2009 5:00 pm EST

Focus: STOCKS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Insiders Plus, finds three utilities whose fat dividends and steady growth may help them beat the market in the years ahead.
 
I continue to believe that good dividend-paying stocks will outperform their stingier peers over the next six to ten years, [and] utilities are a good place to look for steady cash. The ones I’ve chosen get most of their revenues from regulated operations. They’re typically allowed returns on equity in the 10% range.

That’s not likely to attract traditional growth investors, but 10% growth on top of these healthy dividends will surely beat the market over the next decade. In fact, I believe the dividends alone are likely to accomplish that. All three of these companies have strong balance sheets and cash flows.

The most solid and steady of the group is Southern Company (NYSE: SO). It has 4.4 million customers in the southern US. It has a yield of 5.6% at its current price, a payout ratio of 74% and a ten-year total return of 165%, beating not only the S&P 500, but the utilities as a whole. Buy Southern Company up to $34.50. (The shares closed Friday below $32—Editor.)

PPL (NYSE: PPL) generates energy from various fuel sources, including coal, uranium, natural gas, oil, and water. The company also delivers electricity to approximately four million customers in Pennsylvania, other parts of the United States, and the United Kingdom. The dividend yield is 4.7%, but with a payout ratio of only 54%, it has room to grow more quickly than Southern or most other utilities.

Having more of a mix of unregulated income with its regular utility customer income will make PPL’s income stream somewhat more volatile. However, the company only cut its dividend once (41%) in the 16 years for which I have records. That was in 1998. It was back to approximately its old level by 2004 and is now 65% higher than the previous level. PPL has had a total return of 190% over the last ten years, trouncing the market. Buy PPL up to $33. (It closed just above $30 Friday—Editor.)

CPFL Energia S.A. (NYSE: CPL) is a Brazilian utility that gets 63% of its revenues from distributing electricity to 6.4 million customers. The rest comes from electrical generation (primarily), with a little from energy trading, natural gas, and other small businesses. Less than 9% of its distributed electricity is self-generated.

The one sour note here is that the company is paying out about 95% of its earnings to make its 6.5% yield dividend this year. But free cash flow is greater than earnings, and operating income covers net interest expense more than 5.5 times. Earnings are expected to grow about 13% next year, giving more wiggle room.

Given Brazil’s growth prospects, I’m comfortable with the payout being tight here. And speaking of growth, the stock has returned 298% to investors—in the last four years since it’s been listed here. Buy CPFL Energia up to $57.  (It closed below $54 Friday—Editor.)

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