Sunday, May 5

Week 96 - Ten “A”-rated Utility Stocks are Dividend Achievers

Situation: Here at ITR we’re always on the lookout for “safe stocks." Yes, we know and agree that is an oxymoron but there are some stocks that are safe enough that they don’t have to be backed up with AAA bonds such as US Treasury Notes or Savings Bonds. Last week (Week 95), we came up with a list of 11 “hedge” stocks that met our test of “safe enough for investing.” This week we’ve come up with an additional 10 stocks of utility companies that are also “safe enough.” 

The problem with utility stocks is that they’re harder to analyze. When you go to The WSJ website and punch in a ticker, you’ll find that almost every utility stock has negative free cash flow at the end of the year, and is capitalized by bonds for the most part. Typically, its return on invested capital (ROIC) is so anemic that you’ll doubt if it even covers the cost of capital, let alone the cost of its dividend. So skip that website. Just rest assured that utilities enjoy tax expenditures and government backing in exchange for regulation of utility rates that customers pay. For example, electric utilities (e.g. SO, NEE, WEC, SCG in the Table) are regulated by a state government through its Public Utilities Commission (PUCO). That means its bonds are a) tax-free and/or pay low interest, and b) are backed by a state government. The PUCO sets return on equity (ROE) in the range of 10-12% by charging customers enough to maintain that ROE. That translastes into more than a 7%/yr total return for shareholders over time. 

The overriding idea is that while utilities have high fixed costs (i.e., are unlikely to be profitable) they are also a core function of the state. To attract investors to buy the stock and bond issues needed to meet those costs, the PUCO provides sweeteners such as those noted above. The stock owner also has the assurance that bankruptcy won’t occur.    

Bottom Line: Not all utilities are created equal, so be selective (Table). Nonetheless, the tax expenditures that support utilities are sufficiently robust that you can have a good risk-adjusted return simply by investing in a utilities mutual fund (e.g. XLU). But you're likely to do better by setting up a DRIP for one of the 10 utilities in the Table, e.g. if you add $100/mo electronically to a Computershare DRIP in NEE there are no transaction fees. 

The main caveat is that utilities are mostly capitalized with bonds, and a spike in interest rates would drive investors away.

Risk Rating: 4.

Full Disclosure: I maintain a DRIP in NEE.

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