Earlier this week, utility titans Duke Energy (DUK) and Progress Energy (PGN) announced a merger that will create the nation’s largest regulated, electric utility with nearly $37 billion in market capitalisation serving over 7 million customers across six states.
Did the market do back flips? Was there a ticker tape parade? After all, big M and A activity is a positive sign that things are getting better. So what happened? Basically, the market yawned and scratched itself unenthusiastically.
Maybe it was the premium or the lack thereof. In the stock for stock deal, PGN shares are valued at around 46.00 which comes to a lavish, 4% premium at best. Maybe if they had chosen the name “Groupon Energy” the offer might have been a little richer.
However, if you pay attention to utility stocks even marginally, the tepid reaction shouldn’t be much of a surprise. In fact, the market has been treating the utilities this way since 2009.
Last year, the Dow Jones Utilities returned a flaccid 1.5% or so. Of course, if you throw in dividends, the story is a little better. Still, assume 5% or so and while respectable, it was a far cry from the S&P 500’s more than decent 12.73%. And if you go all the way back to what many believe was the structural bottom of March 2009, the Utilities cumulative 36% or so is no match for the S&P’s bruising +90%.
Why the lackluster performance (although nearly 18% a year could hardly be considered lackluster, but when compared to an irrational and somewhat undeserved 45% its hard to get noticed)? Well, if you’re among the crowd that tends to “zig”, as most do, the reasons for avoidance are fairly standard: the great unknown government energy policy that is yet to be determined and the fact that utility stocks are a bit interest rate sensitive (the recent bond sell off has helped support that notion). But for those who “zag” and are looking for value, the utilities appear to be a great place to start shopping selectively.
Names? The usual suspects are typically rounded up: Southern Company (SO), American Electric Power (AEP), etc. Hard to get excited about SO. It’s flirting with it’s 52 week high and the yield has dipped below 5%. If you want to own super, high quality, SO fits that order. Just doesn’t seem to be a whole lot of value there. AEP is a little better. The yield is just north of 5%, but it too is looking over the fence at its 52 week peak. Not that that’s a bad thing. Just not terribly exciting from a price standpoint.
A better idea might be Exelon Corp. (EXC). While the yield is slightly under 5%, the stock trades at 10.69 time trailing earnings. The forward P/E is around 10.5, a 30% discount to it’s peers. Strong ROE and earnings growth as well. The dividend payout ratio is low for the peer group as well at a comfortable 53%. PGN, though now betrothed, is still OK. The premium didn’t materialise on the announcement and by owning it, you’ll wind up with the biggest, baddest, regulated electric utility on the block.
On the fixed income side of things, there’re some six year, Edison Mission Energy (an EIX subsidiary) bonds floating out around there trading at around 90 cents on the dollar and yielding nearly 10%. Yes…they are junk bonds.
No one has ever accused utilities of being sexy. But when everyone else is down 10% because they followed the herd and bought too high, 5.5% is smokin’ hot. Remember the $10 bill in the birthday card your grandmother would send you? It’s a safe bet it was part of a utility stock dividend. As far as segues go, granted, that one was pretty gross. But, as much as we hate to admit it, your grammy, or nanna or bubbe was sexy once, too. Ever seen those photos of the World War Two gals on the home front? Yowza.
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