LOW interest rates over the past several years have been good news for United States utility companies, especially electric utilities. Long-term rates again slipped downward late last week. During the past 12 months alone, more than $4 billion has poured into utility mutual funds from conservative investors seeking high yields, steady and lucrative dividends, and the relative safety of utility companies.
But now, with the direction of both inflation and interest rates uncertain, financial management companies are wondering if changing economic conditions will continue to benefit utilities. Will utilities still be the "safe haven" defensive stocks of years past? Some analysts think not.
So far this year, utilities have done very well. Utility indexes lead a number of major stock groups. The Dow Jones utility index, for example, is up more than 8 percent, compared with gains in the 5 percent range for the Dow Jones industrial average and the Dow transportation average.
"Utility mutual funds are performing well in terms of high yields, and favorable total return on investment, compared to competing investments," says Dennis Dolego, an analyst with Financial Research Corporation. That makes the funds "very attractive" to investors during a period of low-interest rates and economic and political uncertainty, Mr. Dolego says.
Selected utility stocks have not only been outperforming big-name blue chip industrial stocks in total returns, but have also performed well compared with the bond market, says Milton Schlein, an associate research director with Value Line, a New York investment research/advisory service. Unlike bonds, utility common stocks have "no upper limits," Mr. Schlein says. The stocks are not callable like bonds, nor do they have a fixed maturity date.
Value Line has studied the investment records of utility common stocks. One study from 1977 to 1990 concluded that utility common stocks provided a higher total return than bonds, whether interest rates were rising or not. A more recent study reaches the same conclusion. Over a 32-month period ending in the first part of this year, the total return for a 30-year US Treasury bond with an 8 percent coupon and a par value of $1,000 was about 45 percent. The total return on a selected roster of utility stock s was 55 percent.
But whether utility stocks can continue to shine is questionable, many experts say. While utility stocks outperformed broader market indexes in the first quarter of 1993, they have become somewhat erratic. In April, they outperformed the broad market; in May, they underperformed it. In June, they are expected to again outperform the broader market, investment house sources say. Final figures for June are not yet available.
Many analysts, such as Barry Abramson of Prudential Securities Inc., are cautioning customers that, despite current high yields (relative to alternative investments), underlying stock fundamentals for electric utilities suggest that the stocks are slightly overvalued. In addition to the risk of higher inflation, utilities will also face new competition. Electric utility stocks are trading at price/earnings ratios higher than they have been in the past 20 years, as well as lower yields than at any time du ring the same period, Mr. Abramson notes. But the earnings-growth potential for the electric utility industry appears low.
There are several reasons for the expectation of slower growth: The current slow-growth economy reduces the growth in demand for electricity. Some parts of the country have experienced an excess of supply in recent years. There also will be greater competition in the next few years following the enactment of the National Energy Policy Act of 1992, which in part allows independent power producers access to transmission lines of existing utilities. The result, analysts say, will be to lower profit margins for some utility companies.
Some of the more aggressive utilities, however, are setting up nonregulated subsidiaries to compete directly with the independent power producers.