Forget the legacy of Enron and the shadow that it cast over utilities and corporate America as a whole. Today, utilities have managed to return to their more conservative, buttoned-down ways-and that’s benefited their stocks, says Joe Sterling, a portfolio manager for the investment firm American Century. Sterling specializes in the sector that includes power companies, natural gas pipelines, and telecommunications firms. Generally, he says, post-Enron, power companies have returned to focusing on their core competency.
In real numbers that translates into a healthy performance for the sector. Even during a tumultuous summer that saw the S&P 500’s gain for the year whittled down to just under 2% by late August, the Dow Jones utility index rose 8.3% during the same time.
Historically, electric, gas, and telephone company stocks have been viewed as reliable investments that actually thrived in uncertain, volatile markets. Their revenues were steady and
profits were set by state regulatory agencies. Regulation made the utilities easy to track and surprise-free for investors. While utility shares couldn’t boast blazing growth or rapid price gains, they did offer investors a dependable stream of income in the form of predictable dividends.The $460 million fund Sterling co-manages, American Century Utilities (BULIX), was up 11% through late August. Over the past five years, the fund has had an average annual total return of 17.7%.
How are electric utilities faring?
Across the country, this seems to be a very good time. We look for average earnings growth of between 8% and 12% annually over the next three to five years.
Internally, companies began to focus on repairing and strengthening their balance sheets-something that makes the industry seem all the more attractive at a time when corporate junk bond debt and subprime mortgage problems have investors feeling jittery. Meanwhile, demand for power continues to grow at about 2% to 3% a year nationwide.
How do the numbers stack up for stocks in the sector?
Presently, after the nice run the group has enjoyed, dividend yields are in the 3.2% range-they were as high as the double digits when utility stocks were at their lows in 2003. At the same time, some stocks are hovering near full valuation. That said, there is still reason to believe that some members of the group are poised for positive price movement. Historically, the utility group has benefited when interest rates drop because its combination of a reliable dividend yield and potential stock price gains seems very attractive.
Electric utility shares are up. Is there one with more upside potential?
In power generation, we like PG&E Corp. (PCG), the Northern California utility that owns Pacific Gas & Electric. The company came out of bankruptcy a few years ago and now enjoys solid earnings growth-we project about 8% a year over the next five years. Regulators in California learned a lesson from the state’s energy crisis early this decade, and PG&E has been able to boost generation capacity and efficiency in return for increases in its rate base-the incremental price increases that the company can charge for energy or gas.That has lifted the company’s return, revenues, and growth to the top 15% of the electric utility universe.
California seems to be among the bright spots in the generation business. What about a second favorite?
Another Californian: Sempra Energy (SRE), a natural gas and electricity company based in Southern California that owns So CalGas and San Diego Gas & Electric. Like PG&E, Sempra is benefiting from strong rate base growth. Additionally, the company has set up a pretty dynamic power trading
What about a telecom play?
AT&T (T) continues to show good momentum in its wireless and consumer landline businesses. AT&T’s wireless segment, however, will continue to drive most of the company’s revenue growth. Meanwhile, Project Lightspeed, the company’s effort to extend its cable network to homes, seems to be hitting on all cylinders. We see AT&T generating a lot of free cash flow from its business, something that has funded its $10 billion stock buyback recently. In all, look for revenue growth of 7% per year over the next five years compared with 4% for AT&T’s peers.
Sterling’s Picks
| 52-week price range | ||||||
| Company (Ticker) | Price | Low | High | 2007Est. EPS | 200 7P/E Ratio | Comment |
| AT&T (T) | $38.73 | $31 | $42 | $2.76 | 14.0 | As the network provider for Apple’s iPhone, the $236 billion telecom’s wireless revenues should continue to grow. |
| PG&E (PCG) | $43.97 | $41 | $52 | $2.79 | 15.8 | The $16 billion San Francisco firm may grow earnings by 8% a year over the next five years. |
| SEMPRA ENERGY (SRE) | $54.51 | $49 | $66 | $3.93 | 13.9 | Based in San Diego, the $14 billion company has benefited from a solid base of incremental price increases. |
data as of 9/7/07 Source: Yahoo! Finance