Even though I focus on fundamental research, I have to confess that I do look at charts from time to time, especially sector charts. There is a measure that tracks what percentage of each group has bullish chart patterns at a given moment in time and I find these very useful. When a group has less than 10% of the included stocks going up in price, it is usually a pretty washed-out a place to look for bargains. When I was scanning these bullish percent charts earlier this week, I noticed an unlikely industry in the single digits. Electric utility stocks have been battered in recent weeks and have fallen along with the rest of the market.
A Surprise Smackdown
Electric utility stocks have long been considered somewhat recession-proof. Most of them have generous dividend yields and you have to turn the lights on no matter how bad it gets. This recession has been a little different for the group. Industrial and commercial clients have dialed back electricity usage and individuals have turned down the thermostat. Demand also fell in light of a fairly mild winter in the Northeast. Although the majority of utility companies had no dealings with toxic mortgage-backed securities, the credit market collapse did raise the cost of funding for many of these companies. Looking forward, green energy policies and carbon taxes could hurt the bottom line for a lot of these companies. Over 50% of electricity in the U.S. is produced by coal-fired plants and the costs of reducing emissions are going to hurt the utility companies. The reduced tax on dividends expires next year and that has weighed on the group as well.
Attracted by Lousy Circumstances
So we have a group of companies with reduced demand and rising costs combined with political and tax problems looming in the near future. Naturally, that attracts me to the group as a great place to search for bargains. Often when a group faces this many obstacles, they are priced into the stock and then some. Investors will abandon the group and push them to prices far low than circumstances would suggest they are worth. I think that has happened with utility stocks and many of them trade at levels that I think are very attractive from a long term perspective. One of my favorites in the group right now is Duke Energy (NYSE:DUK). Duke serves 3.9 million customers in the southeastern United States, primarily in the Carolinas. In recent years, the company has divested a lot of the unregulated business it acquired after deregulation in the 90s and focused on the ore utility business. In 2006, Duke merged with Cinergy in an all stock transaction and expanded operations into the Midwest. The merger better than doubled the company's service area and is expected to result in cost savings of about $650 million annually. In 2007, the company moved close to the basics, spinning off its gas transmission business, Spectra Energy (NYSE:SE).The Carolina region is growing and revenues and earnings at Duke have held up pretty well in the recession. The company should receive rate increases in much of its service area this year to bolster top-line growth going forward. The stock is pretty cheap on the numbers as well. The shares trade right at tangible book value and 12 times earnings. The company has a generous dividend yield of 6.7% as well, making its total return potential attractive under current market conditions. The shares have lifted a little since the selloff on the proposed carbon taxes, so I would wait for little pullback to pick up shares of Duke.
What Happens in Vegas
Take all the problems facing the utility industry, add the highest foreclosure rate in the nation and the near collapse of the service area's major industry and you start to get sense of the challenges facing NV Energy (NYSE:NVE). The company was just starting to regain its footing after the California electric crisis almost bankrupted the company earlier in the decade. The company operates in Nevada as well as the Lake Tahoe area of California, serving almost 3 million customers in all. Las Vegas was the hot stop for the mortgage crisis, and as the bubble popped many of the homes in that city went into foreclosure and the gaming industry slowed to almost a crawl in the resulting recession. All of this appears to be reflected in NV Energy's stock price. The stock is off almost 30% in the last 52 weeks and trades at just 60% of its 2008 highs. In spite of being caught in what looks like a perfect economic storm, the situation at NV Energy really is not that bad. There was some weakened demand from all the foreclosure in its largest metropolitan service area and the weakness in the gaming sector has not been that big a factor. Casinos are still operating and the Vegas Strip is still ablaze in lights after all. In a recent presentation to investors, company officials noted that while growth for the company was slowing, it has not stopped. In addition, the company is focusing on improving gross margins and cost cutting measures to keep bottom line earnings growth strong. The company has been ahead of the curve on renewable energy. By the end of 2009 it is projected that 12% of the company's electricity will be produced form green sources, primarily geothermal and solar. Statistically it is one of the cheapest electric utility companies on the board. The stock trades at less than 8 times earnings and at just 70% of tangible book value. The stock yield is 4.5% and the company has one of the lowest payout ratios in the industry at just 38%. As conditions improve, that leaves a lot of room for future dividend increases.
Cheap Can Get Cheaper
There are very real challenges facing the electrical utility companies. The move to green energy and dividend tax changes could weigh on these stocks in the year ahead. These fears appear to be already reflected in the current price levels of Duke Energy and NV Electric. Throughout my career, buying utilities at or below tangible book values has turned out to a profitable investment opportunity most of the time. No investment technique is foolproof but this appears to be pretty close for patient, longterm investors. As with all my stock picks in these uncertain times, I suggest you not pile into the stocks. I like the stay small and go slow approach to buying stocks until I am more confident we have seen a bottoming process beginning in the stock market. Be cautious and conserve cash with the idea of averaging into if and when prices fall even lower. Cheap has a nasty habit of becoming even cheaper in the last year. Make that work for you and not against you by building positions slowly.