Scratch a utilities fund these days and you're likely to find a telecom fund in disguise.
Many utilities fund managers, tired of watching their sector get trounced by go-go growth areas in recent years, put a lot of money behind telecom stocks [
Qualcomm (QCOM) in a utilities fund?] and other high-octane sectors. Then a funny thing happened: Many utilities stocks got hot, while many telecom stocks got whacked.
Maura Shaughnessy has dipped into the telecom waters, but the manager of the
(MMUFX)MFS Utilities fund has used more discretion than many of her peers. Her judicious picks yielded an 11% return this year through Sept. 5, besting the 8.6% return by the average utilities fund. While Shaughnessy is a little worried about the high price of many natural gas and electric stocks, she sees more room for growth, especially in perennial bets such as
AES (AES) and
El Paso Energy (EPG).
Maura Shaughnessy |  |
Fund
(MMUFX)MFS Utilities |
Managing Fund Since
Feb. 14, 1992 (inception) |
Assets
$2.1 billion |
YTD Return/ % Rank in Category
10.4% / 32% |
3-Year Return* / Rank in Category
24.8 / 18% |
Load / Expense Ratio
4.75% / 1.05% (A shares) |
Top Holdings
El Paso Energy (EPG)
Peco Energy (PE)
AES (AES) |
| Source: MFS Funds. Morningstar. Returns through Sept. 6. Holdings through Sept. 1. *Annualized. |
1. What industries and companies within the utilities area look attractive to you right now? Maura Shaughnessy: I've been doing this for 8 1/2 years, and I think it's an incredibly difficult time to be a utility fund manager, because you have the electric and natural gas stocks at all-time highs, and the dot-com stocks go down every day.
You have the telecom stocks (some of them I own), which are down 30% to 60% this year. It's not just in the U.S., it's also in Europe; many of those stocks are 50% to 60% off their highs just this year.
Whereas the natural gas stocks, some of which I own, like
Dynegy (DYN) or
Enron (ENE), are up 50% to 150% this year. And even the electrics year to date are up about 19% or 20% -- some of those stocks are up 50% to 70% this year. So it's an incredibly difficult time to be putting money to work, because frankly I think many of the natural gas stocks are a bit ahead of themselves and I've been a net seller.
I still think the fundamentals of the electric stocks are pretty positive. The two biggest names I own there are
Peco (PE), which will be merging with
Unicom (UCM) in the next month or two. They have a really smart wholesale strategy and there's going to be a lot of synergy out of the Unicom deal.
The other stock I really like in the electrics is
Pinnacle West (PNW), out in Arizona. They have the best low growth in the country, with customer growth over 4% a year. They also have a very smart generation strategy where over the next few years they'll be bringing in a new generation on a deregulated basis that will be able to take advantage of a very tight Southwest market. Bill Post, the CEO, I think is a very smart guy. Even though those stocks have been good this year, I've maintained pretty solid positions.
On the natural gas side, my favorite stock is El Paso Energy. They'll still be the No. 1 natural gas pipeline play in the country when they combine with
Coastal (CGP) in October.
Dynegy is now at a price-to-earnings multiple of 30 times, Enron's about 57 times and El Paso is still only around 18 times, and I feel pretty confident that the merger's going to go well.
And if we actually have a winter, the natural gas business could be extremely tight. A lot of companies on the utility side have benefited over the last month or two where places like California have been very short on electricity and the pricing has been extremely volatile and higher than it otherwise would be, given this warm weather and shortage of capacity.
2. On the flip side, what are some industries and stocks that look a bit pricey? Shaughnessy: Some of the natural gas stocks have run pretty fast. I'm not going to dump on any one specific name, because I may own a little bit of it or I may be trimming it.
I'd point to some of the natural gas stocks and power stocks, companies like
Dominion Resources (D) or
Reliant Energy (REI), which are up 50%, 60%, 70% this year because of this big shortage-of-power play.
But I think those stocks have some air underneath them. I'd say the same thing with
Calpine (CPN). It's up 200% this year. People are just assuming they grow to the moon. My feeling is that there's a lot of momentum-type investors in a stock like that now and perhaps they don't necessarily understand what they own.
3. There are still people out there that think of the utilities sector in terms of what it used to be -- a slower growth, high-dividend area. Now it seems the sector line should be redrawn, because the average utility fund has less than half of its assets in what people think of as utilities. What is your view of utilities and utilities funds today? Shaughnessy: I think the reality is that utility investing changed years ago. It's just that the press is finally awake now. Deregulation has been going on for six or seven years.
Because this deregulation has been changing over time, it's been a stock picker's game for a number of years, and that's really the way that I've approached it. We've tried to take a flexible approach to utilities. Having said that, if you look at some of the utilities funds, the No. 1 performing utility fund last year had Qualcomm as its biggest position.
Qualcomm should be in a growth fund, not a utility fund. I think people need to understand what they own and certain funds shouldn't be called utilities funds any more.
I've always believed that it's very important to provide very good income for a utilities fund, but the way I've gone about that is pretty different. I've had about 10% to 15% of the assets in bonds, just Treasuries and utility bonds. I've had about 10% to 15% of the assets in convertibles, but rather than continue to cut the dividend on the fund (and some of the utility funds have almost no yield now), I've maintained a yield at least equal to the Lipper utility average yield. In the last year or two, it's actually been substantially higher because of all the cutting of the dividend. I think when someone is investing in a utility fund, they should get some income, because that's really what it's about.
What's interesting this year is that the very best performers are the ones that are very plain vanilla funds, with natural gas and electrics stocks, that over the last several years have not done well.
Many of the funds over the last few years have really loaded up on telecom. As I mentioned, telecom has been awful, it's certainly hurt my performance a great deal this year, but fortunately I had a lot of natural gas stocks to help. So, I mean, it's interesting this year that the companies for the funds that really stretch by having 70%-80%-90% of the assets in telecom have very bad performance. I guess everything comes back to roost at some point or another.
4. How much of the fund is invested overseas, and what opportunities do you see over there? Shaughnessy: I can go up to 35% of the assets international, and last year it was as high as 35%, because we had some really big bets on some of the telecom stocks in Europe. Fortunately I sold some of them, and unfortunately the market has cut some of them for me, so the international position has fallen to about 26%-27% of assets.
Of the two biggest positions internationally, one is
Endesa (ELE) of Spain. It's a real solid electric utility. Consumer demand in Spain has been really strong. Endesa did some smart investing in Latin America; the stock has been a bit of a laggard lately and I'm not sure what the catalyst is, but I think it's pretty good value.
A more controversial name is
Vodafone Airtouch (VOD). Vodafone was involved with the bidding in Europe for Umts licenses, which are the third-generation licenses on cellular. In the U.K. and Germany, the service providers paid a lot more for the licenses than anyone expected, and it's hard to understand how they can actually generate very good returns based on how much they paid for the licenses. So many of these stocks have really been killed, 50% to 60% off their highs.
Vodafone now is down to about 15 times cash flow for a 20%-to-25% cash-flow grower. And I think all the bad news is out there. The only problem is that there will be about $70 billion to $80 billion in potential equity raised in European telecom over the next two to three quarters, which will certainly not be a reason for the stocks to go up a lot.
So Vodafone's a very good value. I'm not sure it's going to be a home run any time soon, but it's been sufficiently hammered that it could be a decent story.
5. What are the implications of privatization in electric utilities and telecom firms? Shaughnessy: When you think of most countries, especially in emerging markets, the industries that are privatized initially tend to be the utilities, energy and telecom. Many of these deals -- such as one in Turkey, which just privatized its cellular company,
Turkcell (TKC) -- there's new privatizations. There also can be secondary offerings of companies as big as
Deutsche Telekom (DT) or
NTT (NTT) in Japan, where the governments are selling down their stakes to get below 50%.
We really haven't seen that many privatizations in the utilities area, and you just have to be very careful of the price. One of the biggest deals over the past year was the Italian electricity company called
Enel (EN).
I'm not even sure if it's ever seen its IPO price. It was priced so poorly, and I hear that the government wants to try to sell a second tranche. I can assure you that that deal won't go well.
So you just really have to understand the risks inherent in the privatization and/or the secondary and how the valuation looks. I'd say four or five years ago, it was very easy to make money on these deals. Now that there are so many of them, it's actually much harder to do that, and most of the deals haven't been all that successful, at least in the last six or nine months.
6. What are the implications of deregulation on the domestic side? Shaughnessy: In the telecom sector, and I'm including cable and satellite as well as the local companies and long-distance companies, everyone is getting into everyone else's business.
So there are two trends to watch: first, the pricing compression that's occurred, which would certainly benefit consumers (and that's especially true in the long-distance area). The other aspect is the rush to the ownership of the last mile.
Who's going to get to that local customer with fast Internet access? Is it the satellite guy, is it the cable guy or is it the regional Bell operating company? That's through either cable modems or digital subscriber line service. And that last mile is really where the bottleneck is throughout the network right now, and so there's a real rush as to who's going to win there.
My bet is that it's not really about the technology, it's about which company can execute, which will determine who will be the better stock.
On the electric side, the real deregulation has occurred on generation. The basic electricity into your home is going to take a lot more time before you have customer choice there in any material way.
Generation has become deregulated, so it's subject to the whims of the market. Therefore, electricity prices may be much more volatile than they ever used to be. We've seen that in the West Coast this year as both consumers and industrial customers have paid the price of more volatile and higher prices. The U.S. generation market in general has very much underinvested over the last several years.
Now that we actually need it, there's a shortage in certain areas, which obviously causes higher prices. The question there will be will regulators reregulate the industry, which there's some talk of that happening.
7. What do you see as the major growth trends in your area in the next five to 10 years? Shaughnessy: A big trend in telecom is wireless. But aside from just benefiting from overall growth in wireless demand, it's the degree to which new services will add to the party in terms of putting the Internet on your phone and these sort of things. A lot of that has been hyped a bit and we have yet to really see.
On the electric and natural gas sectors, the big question is who can win from this new generation game. Is it all just about building plants? Or is it also about being smart in terms of where you invest those plants, and how exposed to the stock market you are?
Right now, there's a lot of growth going on in what they call the distributive generation market. Leave it at that, I'm sorry I meant to clean that up.
8. The average large-cap growth fund has its biggest underweight in the utilities area. Do you think some of those folks are going to pay more attention, and buy up these stocks, or has that occurred a bit already? Shaughnessy: I don't think they've played as much the plain vanilla-type stocks like those I've mentioned -- Dynegy, Enron, Calpine, and other independent power companies.
I mean all these do have pretty significant growth, north of 20%. There's no reason that growth managers shouldn't follow those, but I would say for someone who's been investing in that area for a long time, it's not likely that they would be buying the stocks here.
It's more likely that the new buyers, which perhaps may be growth investors, are the ones who are buying them now. All you need to do is look at the charts that the momentum gods are working in your favor.
9. If you had to pick three stocks to hold for five years, what would they be? Shaughnessy: AES. It's the most diversified independent power company, with a big international presence as well as a domestic presence. They've been doing this a long time.
I would put Enron as two, even though the stock has run a great deal. That's definitely a core position.
Lastly, I would go with Pinnacle West. I mean this is to play a really solid single in the land of the electrics. I'm very confident that the management's going to continue to execute and they also have the wind at their back by being in such a great service territory. It's not a big growth investor stock, it certainly doesn't warrant just this 11.5 P/E with 10%-12% earnings growth that I can see sustained for many years.
10. What's the last new name you added to the utilities fund, and what's the last name you added to your personal portfolio? Shaughnessy: I haven't invested personally for about six or seven years. For the fund, it's
AT&T Liberty Media (LMG.A).
It's basically a telecom media holding company that I was never interested in before because it would always trade at a premium to its net asset value, but it's now selling at about a 22% discount to its net asset value.
Many of the names in its portfolio haven't been performing well. So I think Liberty Media looks pretty cheap right now, relative to its asset value. It's the first time I've ever owned it, actually.
One of the rumors out of AT&T was that they were going to put the long-distance business into Liberty Media, which would obviously make Liberty Media stock go to zero. Given that [Liberty Media Chairman] John Malone is on the board of AT&T, I don't believe that would happen. I can't believe Malone would screw himself that much.
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