Stability utility stocks gain new interest after a shaky period
Unless you go for white-knuckle amusement park rides, the Dow Jones industrial sector has probably not been your investment vehicle lately. Last week, health-care stocks, an institutional darling, were the latest group sent for a loop. After 17 years of gains, Hospital Corporation of America reported it would have flat earnings in 1985 and again in '86.Skip to next paragraph
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With that, the entire industry fell from grace. Many analysts had been recommending these stocks, expecting 15 percent earnings growth for years to come. HCA's announcement shattered their faith.
Meanwhile, takeovers -- real and imagined -- continue to buoy the Dow. With Procter & Gamble buying Richardson-Vicks and Philip Morris swallowing General Foods, takeover speculation is spreading.
It ran the gamut from Beatrice to Texas Oil & Gas to CBS last week. This frenzy contributed to the heavy trading volume on the Dow Jones industrial average, which finished the week up 7.95 points, at 1,328.74.
Which brings us to electric utilities.
These issues are known as ``widow and orphan'' stocks, because of their relative stability.
They are not without risk, however.
After a long run-up over the past year or so, utilities fell from favor in late July.
As it became apparent that the economy would rebound and interest rates firmed up (a negative for utilities), a selling spree hit. On July 23, the Dow utility index had its biggest loss in more than two decades.
The correction had been predicted, but its swiftness was unexpected. Since their highs in early July, utility stocks have generally slid by about 10 percent.
Lately, however, utilities been showing some strength again.
It's a flight to safety, reflecting concern about the market in general, figures Steven Ballentine, manager of Prudential-Bache Utility Fund. Despite the July drop-off, his fund has shown a 12.5 percent gain on the year.
By comparison, the Standard & Poor's 500 index is up 10.25 percent since Jan. 1, and the S&P utility index has risen 5.8 percent.
At Advest, a Hartford-based brokerage house, William M. Brunet says some buyers have come back to utilities because ``we've now reached the point where there are a lot of bargains. Yields are moving from the 7 to 8 percent range into the 9 to 9.5 percent range.''
None of the utility analysts contacted expect their stocks to chalk up huge price gains over the next six months. The costly cleanup after hurricane Gloria could hurt the earnings of several New England utilities.
A drop in interest rates, however, would boost share prices. And utility yields overall seem attractive.
``We view electric utility stocks as having a total return of about 14 percent over the next 12 months. That is, a 9 percent average current yield and 5 percent dividend growth,'' Mr. Ballentine says. He expects interest rates to remain fairly stable. ``If interest rates rise, we'll see less appreciation in dividends.''
While expecting only ``moderately higher'' stock prices and ``yields of 9 percent or so,'' Warren Casey, manager of the Boston-based Fidelity Group's Select Utility fund, thinks that will be enough to outperform the industrial sector in the year ahead.
``If it weren't for this takeover craze, the industrials wouldn't look that good right now,'' Mr. Casey says. ``Technology stocks are still in the tank.
``Over the next 12 months I think Wisconsin Electric Power will outperform IBM,'' he adds.
Casey's was among the top performing mutual funds over the last year, up some 40 percent. So far this year, his fund is up 13.47 percent.
All three of these utility-watchers have steered clear of troubled nuclear projects. They are quick to point out that they do not hold stock in such companies as Middle South, Kansas Gas & Electric, Consumers Power, Cincinnati Gas & Electric, Public Service of New Hampshire, and Long Island Lighting.
The prevailing feeling is voiced by Mr. Brunet at Advest: ``I buy utilities not to speculate but for secure, growing income.''
Indeed, such candidates appear numerous.
``In general, the financials look quite good,'' says Ballentine. ``The large construction phase is over for most. Growth in electricity usage has slowed.''
With a nice capacity cushion and less capital spending, the result is more cash flow. A pickup in the economy would mean more demand for juice, and even better earnings.
Utilities are already beginning to use that cash to diversify and buy back their own stock. Analysts are debating whether the extra cash will spark a high-profit merger craze among utilities. Ballentine doubts it.
There may be mergers between weaker utilities, he suggests. But the big payoffs shareholders reap from industrial takeover targets are unlikely.
``The financially strong companies with the most attractive cash flow are already selling at 130 percent of book value,'' says Ballentine. And since regulators limit the investment return on plant assets, the economics just aren't there.
Among Ballentine's largest holdings are Consolidated Edison and Northern States Power. At Fidelity, Casey's big stakes are in New England Electric System, Dominion Resources, Eastern Utilities Associates, Boston Edison, and Pacific Lighting. Mr. Brunet at Advest is recommending Allegheny Power, Public Service of Colorado, and Midwest Energy. Chart: Interest Rates. *Yields; Source: Bank of Boston.
Percent Prime rate 9.50 Discount rate 7.50 Federal funds 7.69 3-mo. Treasury bills 7.98 6-mo. Treasury bills 7.24 7-yr. Treasury notes 10.32* 30-yr. Treasury bonds 10.62*