These 5 Stocks Are Essential

10/19/2011 8:30 am EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

Investors have been willing to pay up for safety, but investors are still "de-risking," and that has had wide-ranging effects says Roger Conrad of Utility Forecaster.

If you want any sort of income today, you’re going to have to own dividend-paying stocks.

In fact, with corporate borrowing rates at their lowest levels in generations, the only bonds with decent yields are on the higher-risk end of the spectrum, such as Level 3 Communications 8.75% Note of 02/15/17 (CUSIP: 527298AL7).

The downside to stocks in this environment is, of course, that you’ve got to live with a lot of volatility. That won’t cost you more than a little heartburn, provided the companies you own are still running well. But when a company does stumble, it can go down in a hurry, with little hope of timely recovery.

That appears to be the case with American Superconductor (AMSC). Last month, I cut the stock to “hold” for speculators only. This month I’m exiting for a sizable loss.

The company is now suing its erstwhile largest customer, China’s Sinovel Wind Group Company, for technology theft in Chinese courts. Management is confident of a turnaround. But the premise under which I recommended the stock no longer exists, so I’m out. Sell American Superconductor.

Fortunately, the businesses behind many stocks are still meeting management guidance for growth and dividend coverage. As long as that’s the case, they’ll recover whatever stock-market losses they suffer in coming weeks.

Some have come down hard in recent weeks. Worst hit have been my energy producers, which investors seem to be unloading on expectations of sharply lower oil prices.

Energen Corp (EGN), for example, has dropped from a mid-summer trading range in the mid-60s to the 40s. Chevron (CVX) is back around $100 after surging nearly to $110. MDU Resources (MDU) slipped as far back as the high teens, and ARC Resources (Toronto: ARX) just bounced back to the mid-20s after a similar drop.

Each of these companies’ profit is affected by energy prices. All of them, however, also have exceptionally conservative finances, rising production profiles, and aggressive hedging. MDU and Energen operate regulated utilities that both shield earnings from ups and downs in commodity prices and completely fund dividends.

ARC did trim its distribution in 2008-09, as oil fell from over $150 to less than $30 a barrel. But second-quarter 2011 cash flow covered its payout by a 2.5-to-1 margin at a realized selling price for gas (64% output) of just $4 per thousand cubic feet.

That implies a great deal of cushion for the current dividend of about 5%, even as the company appears on track to boost daily output another 10% by the end of the year.

Finally, all of these companies had the cash in 2008 to keep on investing and growing, and they’re even stronger now. In the unlikely event of a reprise, they’ll live to fight another day.

And in the far more probable case that markets stabilize long before such a calamity becomes reality, today’s levels will prove great entry points. Buy Energen (up to $55), Chevron ($100), ARC Resources ($25) and MDU Resources ($24).

Telecom Could Become a Huge Short Squeeze
My worst performer this year, Frontier Communications (FTR), is a favorite target of short sellers, with bets against totaling more than six times daily volume. The bear view is the company won’t be able to hold its quarterly dividend of 18.75 cents per share, given the 9% rate of access-line losses in systems purchased from Verizon Communications (VZ) in July 2010.

The bull bet is Frontier will meet management’s target of $600 million in cost savings from the deal, and will cut access-line losses at the new lines to the 6% rate at its other systems. Last month, management generally affirmed that it’s meeting these targets, though it reduced the midpoint of free cash flow guidance by about $50 million to $1.125 billion, largely on hurricane and system-conversion costs.

CEO Mary Agnes Wilderotter affirmed the dividend as “safe and secure” and said she expected better “business revenue performance into 2012.” And four officers and directors have made open-market purchases in the past two months, with no sellers.

It boils down to this. If the bears are right, this stock is probably headed under $5. If the bulls are right, there’s the potential for the mother of all short squeezes.

Considering management’s track record of generally accurate guidance, I like the bull case, with one caveat: Only buy Frontier Communications stock if you don’t already own it. Otherwise, just let it ride. That’s the best way to stay unemotional enough to sell if circumstances dictate.

Subscribe to Utility Forecaster here...

Related Reading:

6 Market-Beating US Income Stocks
Profit from the Aussie Carbon Tax
6 Undervalued High-Yield Stocks

Related Articles on STOCKS