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Sep 06, 2010
US Utility Stocks Could Look Attractive If Markets Stay RoughFeb 05, 2010
By Brendan Conway
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--Regulated utility stocks may sound unspectacular, but if the market stays this volatile that may be a blessing. And they'll look all the better if the political risk lessens.
The Dow Jones Utilities Average has dropped more than 7% this year, compared with the S&P 500's fall of 4.6%. As the markets took their biggest swoon in months Thursday, the utilities index fell 2.6%, and was off nearly 1% recently to 367.17.
In other words, these income-oriented stocks seem to be pricing in an awful lot of negatives lately. In fact, the relative price-to-earnings ratios of utilities haven't been this low since the Enron debacle in 2002, notes East Shore Partners' Gordon Howald.
The typical regulated utility--companies including Consolidated Edison Inc. (ED), Duke Energy Corp. (DUK), and Southern Co. (SO)--is set to pay out more than 60% of expected 2010 earnings in dividends, according to a recent Morgan Stanley analysis. They yield about 4.8% on average. That could make the stocks a haven for investors convinced that equities' recent woes will continue.
The risks are largely about politics, regulation and energy prices. But at least some of the political matters are looking better lately. A big one is the unlikelihood of a global-warming bill. Credit Suisse analysts recently said the idea "feels dead" for this year.
But arguably bigger is dividend taxation. Here, the news got better this week. President Barack Obama opened the door to what could be an end to investors' dividend-tax guesswork when his budget included no rate-sunset provision. The president seeks to hike dividend- and capital-gains taxes to 20% from 15% for the wealthy and cement 2009 rates for others.
"That was one of the better outcomes the utility industry could hope for," Howald says. Permanent rates would be an immediate plus because investors would be much more capable of assessing future payouts' value. The subject is now on the table for Congress. The stocks could shoot up if lawmakers signal a willingness to go along. They would suffer if Congress does nothing since tax rates could rise to their pre-Bush administration levels. But in an election year, tax hikes any bigger than those already proposed seem unlikely.
Another big politically oriented risk may be already reflected in today's valuations: Rising interest rates and Treasury yields. When rates surge, dividend-heavy utility stocks do the opposite.
But it's important to note that regulated utility stocks tend to underperform in anticipation of interest-rate hikes and a rise in 10-year Treasury yields--not after them. The trend is robust enough that Morgan Stanley's Gordon cited them for a downgrade of the sector to "cautious" from "in-line" last month.
Rate hikes are already widely anticipated for this year. Credit Suisse analysts noted this week a majority of respondents to their utility investor survey now expect 10-year Treasury rates to hit the 4.5%-5% range by the end of 2010. Expectations for the Federal Reserve to tighten later this year are also widespread. That could mean a lot of the underperformance is already happening.
There are still plenty of political and regulatory risks, prominently at the state level and with the Environmental Protection Agency. An investor must also be comfortable with energy investments in a year when demand and pricing aren't looking very bullish to a lot of analysts.
Even so, stalling equities and a rocky S&P 500 will tend to make these stocks look more and more attractive. As East Shore's Howald puts it: "Stodgy, dull and boring may not sound that good, but in a market like we have now, it's certainly not the worst place to be."
-By Brendan Conway, Dow Jones Newswires; 212-416-2670; brendan.conway@dowjones.com [back] |
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