But utility investors today can’t rely on the lessons of the past. Deregulation is going to spin through this stuffy industry like a twister. You won’t even be able to count on the stocks for support when the market flattens or falls. Sometimes they’ll hold up; sometimes they won’t.
So why look at utilities today? Because they carry two interesting investment stories.
Story one, for traditional income investors: Good utility stocks are yielding nifty dividends today–between 5 and 6 percent, compared
But deregulation may change all this, warns the Washington International Energy Group (WIEG). In a recent survey, 42 percent of investor-owned utilities said that, over time, they expect to reduce the portion of earnings they pay out in dividends. Your income could quit growing and might even decline. So you can’t blindly buy your local utility anymore. You have to think.
Story two, for those seeking capital gains: You may have an opportunity play. Utility stocks got hammered in 1994, when interest rates
The tricky bit is finding stocks that can prosper in a less regulated world. To be blunt, utility CEOs haven’t had to be too bright, except at outwitting state regulators. Now their monopolies are going to be pulled apart. The process is already underway in California, New Hampshire, Pennsylvania and Rhode Island. Several other states are almost ready to move. To prod the slowpokes, both Congress and the White House are considering bills that would set a date–say, 2001–for competition to begin.
Eventually, most utilities will no longer own their neighborhoods. Marketers of electric power will buy where it’s cheap and deliver it to distant customers for less than they’re paying now.
But which customers? Households and small companies probably won’t see their costs decline by very much except in high-priced cities and states (Chicago, San Diego, New York), says WIEG’s president, Roger Gale. Huge discounts are in the offing, however, for major commercial and industrial firms. As a result, the sale of electric power will become a less profitable enterprise. For earnings and dividends to grow, utilities will have to merge and purge, and buy or invent new businesses.
They have plenty of cash to do the job, says economist Charles Studness of Studness Research in Manhasset, N.Y. State protection has kept the companies’ revenues high even though–thanks to excess power supplies–they don’t have to build new generating plants. So the CEOs are gearing up for a historic shopping spree. Some will buy wisely, others none too well–and shareholders will pay.
When you own a utility stock today, you actually have three businesses with three different levels of risk, says Bruce Radford, editor of the Public Utilities Fortnightly in Vienna, Va. There’s the power-generation business–a crapshoot, where success depends on being a low-cost producer. There’s transmission and distribution–the wires that let people turn on their lights. Here monopoly will persist, with regulated profits and rates. And there’s marketing–the growth business, where utilities will have to compete for the most profitable customers.
As electric utilities break up and recombine, the most successful will excel in marketing and new customer services, Gale predicts. They’ll buy natural-gas companies, to sell both kinds of power; they’ll joint-venture with telecommunications companies, and they’ll judge themselves more by earnings growth than by the dividends they pay.
With all these crosscurrents at work, it’s smarter to own a portfolio of utilities than to pin your hopes on one or two, says David Kiefer, manager of the Prudential Utility Fund. These specialized industry funds all have at least 65 percent of their money in electric and water utilities, natural gas and telecommunications. But some lean toward income and some lean toward growth. To figure out which is which, check the manager’s letter and the fund’s current holdings in its latest client report.
Traditional income investors will want pure utilities plays, with quality stocks whose dividends they think they can trust. Two examples, according to Morningstar analyst Peter Di Teresa: Colonial Utilities and Vanguard’s Specialized Utilities Income. Growth-and-income investors might look for funds that also buy utilities abroad–say, Franklin Global or AIM Global. Prudential Utility also has a big foreign stake today. MFS Utilities hunts for growth among smaller stocks. Lindner Utility takes a broad enough view of the industry to include satellite companies and cable TV. Some funds beef up performance by buying nonutility stocks–something to check before you buy.
If you’re choosing stocks yourself, here are a few things to look for, says Lowell Miller of Miller/Howard Investments in Woodstock, N.Y., which runs the small BTB Fund and Total Return Utilities Fund: (1) A low-cost energy producer, defined as charging a retail price of no more than seven cents per kilowatt hour. (2) No nuclear plants. (3) Dividend payouts not exceeding 70 percent of the company’s earnings, which should make them pretty safe.
Here’s how WIEG sums up the industry outlook. For some utilities–too late to survive. For others–a three-year window in which to re-create themselves. For the future–““watch out, as marketing of electricity becomes North America’s most costly and risky business.’’ Not a soul knows how it will all turn out.
