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Electric Utility Stocks have long been a favorite of income-oriented investors, and for good reason. The average yield of stocks in this industry is currently 3.9, well above the Value Line mean of 2.55.

Although current income is the primary allure for most electric utility investors, these companies have other attractive aspects, including their defensive nature. In difficult economic times, consumers may run their air conditioners less, but they still want to keep the lights on. Indeed, most electric utility stocks are less risky, and less volatile, than nonutility issues, as evidenced by their average beta of .71. Still, this is certainly not to say that they’re risk free —no investment is. Of course, there are tradeoffs. Although these issues are well suited to risk-conscious income investors, capital appreciation is usually limited, making them unfit for growth accounts.

To create our list, we ran a simple screen of stocks in the Electric Utility industry to find those with yields of at least 4.0%. We also required that all issues were trading above $5.00 a share, and to help ensure the dividends were sustainable, we limited the results to those companies with long-term debt as a percentage of total capital below 50%. Investors should keep in mind that stocks with a high yield are not necessarily more attractive than those with a low yield. The yield is a measure of valuation, and a high yield simply indicates that the stock is cheaper, not necessarily better. Indeed, a significantly above-average yield on an Electric Utility stock is often an indication that there is at least one matter of concern with the company. Our screen returned 9 names (see list below), of which, we have chosen to highlight The Southern Company (SO) and Pepco Holdings (POM).

The Southern Company

The Southern Company, through its subsidiaries, supplies electricity to 4.4 million customers in about 120,000 square miles of Georgia, Alabama, Florida, and Mississippi. It also has a competitive generation business. The company's revenue composition was as follows: residential, 35%; commercial, 30%; industrial, 19%; wholesale, 11%; other, 5%. Its retail revenues by state are: Georgia, 51%; Alabama, 33%; Florida, 9%; Mississippi, 7%. SO's generating sources include; coal, 49%; oil and gas, 28%; nuclear, 15%; hydro, 2%; purchased, 6%. Fuel costs accounted for 39% of revenues. (All figures are for 2011.)

Southern Company’s utility subsidiary in Mississippi has reached a regulatory agreement with the state commission. Mississippi Power is building a coal gasification plant that had cost overruns. (It is scheduled for commercial operation in May of next year.) The agreement limits the utility to earning a return on $2.4 billion of capital costs, plus the cost of pipeline (a total of $377 million). In conjunction with the project, Mississippi Power has filed a request for a seven-year rate surcharge of $172 million. A decision from the commission could come as early as April. Provided that legislation is passed in the state, Mississippi Power will issue securitized bonds, likely between $700 million and $800 million, to recover cost overruns upon commercial operation, but will not earn a return on these expenditures. Therefore, unless any costs are deemed imprudent, the utility won’t have to take a writedown charge.

We look for moderate bottom-line increases both this year and next. Only slight volume growth is likely, however. Southern should obtain some rate relief this year from formula rate plans at some of its utility subsidiaries. Our 2013 bottom-line estimate is within company guidance of $2.68-$2.80 a share.

We look for a dividend increase at the board of directors’ meeting, which is taking place in the second quarter. We estimate a 4.1% increase, equivalent to $0.02 a share, in the quarterly disbursement. This would add to the equity’s already solid dividend yield of 4.28%.

Pepco Holdings

Pepco Holdings consists mainly of three electric utility subsidiaries; Potomac Electric Power, serving Washington D.C. and adjoining areas of Maryland; Delmarva Power, which serves the peninsula area of Delaware, Maryland, and Virginia; and Atlantic City Electric, serving southern New Jersey. Pepco has 1.8 million electricity customers and 124,000 gas customers. Electricity breakdown: residential, 30%; commercial, 49%; and other, 21%.

Pepco has several upcoming rate cases. During the fourth quarter of last year and the first quarter of 2013, the company will be or has filed rate cases in all jurisdictions with the exception of New Jersey. Although treatment has been less than attractive in recent cycles, we estimate the current round of cases may well result in a good pickup in regulatory lag for Pepco. Conditions in Maryland, which accounts for 33% of POM’s regulated rate base, may also get a boost from the creation of the Grid Resiliency Task Force. The agency published a report in the December period recommending stronger reliability and restoration regulations and accelerated investment to meet them. Assuming this helps to reduce regulatory lag, it might well lead to greater earnings power for Pepco.

Recent litigation issues have raised some concern. Pepco is currently engaged in litigation with the IRS over cross-border energy leases, which, depending on the outcome, may result in substantial charges this year. Estimates suggest that a worst-case scenario would have the company incurring roughly $800 million -$900 million in past federal and state income tax benefits, interest, and additional penalties. If this were to happen, our 2013 full-year profit target would be pared by roughly a dime a share.

Pepco stock has one of the highest yields in the Utility Industry. They are currently yielding over one percentage point more than the industry median. Income-oriented investors should look here, as these shares currently offer above-average total return potential (by utility standards), based on our current projections.

 

 Company

Ticker

Dividend Yield

Ameren Corp.

AEE

4.59

Empire Dist. Elec.

EDE

4.51

Integrys Energy

TEG

4.6

Consol. Edison

ED

4.02

Duke Energy

DUK

4.3

Pepco Holdings

POM

5.01

Public Serv. Enterprise

PEG

4.23

Southern Co.

SO

4.28

Hawaiian Elec.

HE

4.52 

     

At the time of this writing, the author did not have any positions in any of the companies mentioned