10 Dividend Rich, Deal Ready Utility Stocks Ready for a 2012 Jolt

NEW YORK ( TheStreet) -- U.S. utility stocks were a safe way to escape a worsening economy last year with many utility sector funds -- like the Vanguard Utilities ETF ( VPU) and the Utilities SPDR ( XLU) -- significantly outperformed the major indices in 2011.

The sector was boosted by its stable revenues and high dividends, which attracted safety-minded investors as the yield on U.S. Treasury bonds plunged. In 2011, mega-mergers also led a continued utilities recovery from a 2009 lows as companies looked at consolidation as a way to wrench out cost synergies and lower pressure on operating margins.

While $10 billion deals may not be as common in 2012, Fitch Ratings expects continued utilities M&A and gives 10 companies to watch for as possible acquisition targets.

The keys to the expected utilities M&A wave in 2012 are threefold. Chiefly, regional powerhouses with non-regulated merchant power businesses are going to look at tie-ups as a way to create cost synergies to overcome falling natural gas and electricity prices. Meanwhile, others may look to diversify their unregulated customer bases to those with regulated contracts, less vulnerable to falling energy prices.

With an uptick in expected 2012 capital spending throughout the sector, others may target development synergies, while also looking to vertically integrate power generation capabilities with retail distribution businesses, according to Philippe Beard and Glen Grabelsky of Fitch Ratings.

"Fitch Ratings expects the industry will continue to consolidate in light of its balkanized structure, and to potentially realize meaningful economies of scale and cost efficiencies," the firm notes in its report on M&A targets in the unregulated utilities sector.

Because of diversification and margin needs throughout the utilities sector, Fitch Ratings expects a year of strong M&A, especially among targets with a sub-$5 billion market cap. That would be a slight change from past years, where a $25 billion stock mega-merger between Carolinian powerhouses Duke Energy ( DUK) and Progress Energy ( PGN), a $10.2 billion tie-up between Mid-Atlantic players Exelon ( EXC) and Constellation Energy ( CEG) and Northeast Utilities System's ( NU) $6.8 billion Oct. 2010 acquisition of NSTAR ( NST) drove overall M&A.

As result of those deals and others globally, the utilities sector was the fourth leading deals sector, with over $250 billion in M&A globally, according to Dealogic.

For more on M&A, see 10 top rated Morningstar M&A picks.

"We would have to see when the current deals will close to have a better sense of whether big mergers will happen in 2012. Size is not necessarily the most important element," says Philippe Beard of Fitch Ratings, who cautions that M&A in the sector may not eclipse the 2011 mark of $49 billion. With the bulk of regulated utilities at less than $5 billion in market cap and just a handful over $25 billion in size, Fitch highlights the latter as they become targets in 2012 for larger players like Berkshire Hathaway ( BRK.A)-owned MidAmerican Energy, Xcel Energy ( XEL), NextEra Energy ( NEE) and Wisconsin Energy ( WEC).

"Fitch believes that smaller companies with market capitalization less than $5 billion and book multiples less than 1.3x, represent better financing opportunities for potential purchasers and more likely targets," writes the ratings agency in its M&A report.

Still, both Beard and Grabelsky of Fitch Ratings caution investors against expecting high premiums. Companies looking at consolidation as a means of enduring pricing pressure aren't going to pay significant premiums to target price-to-book multiples, according to Grabelsky. Mergers in utilities sector averaged a one month share premium of roughly 20%, the lowest premium of the top 10 M&A sectors globally in 2011, according to Dealogic.

A potential headwind are the still pending regulatory approvals of Duke, Exelon and Northeast Utilities Systems' multi-billion dollar takeovers, however Fitch expect that the deals will close. A recent Barclays Capital report shows that even after a utilities merger is announced, investors can find outsized returns by holding the target and acquirers stock through the sometimes multi-year regulatory approval process. If an investor owned the target after the deal announcement through a deals closure, they would earn a 9.1% return, while the acquirer would yield 3.5%.

As utilities stocks and indices hit post-crisis highs and dividend yields continue to provide attractive returns, also look at M&A in the utilities sector as driving investor gains - even as the industry faces pricing headwinds.

Here's a look at 10 potential regulated utilities M&A targets that Fitch highlights in its deals outlook for the sector.

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10. Pepco Holdings

Fitch highlights Pepco Holdings ( POM) its the largest potential utilities target, with a market cap of $4.5 billion. The Washington, D.C. -based utility transmits, distributes and supplies electricity and natural gas to the Capitol region and the Mid-Atlantic through its Potomac Electric Power Company, Delmarva Power & Light and Atlantic City Electric subsidiaries.

While Pepco Holdings' largest subsidiary is Potomac Electric, which serves electricity to 778,000 Washington, D.C. customers, its other subsidiaries have roughly half a million electricity customers, while Delmarva Power also delivers natural gas to 123,000 customers in Northern Delaware.

The company's stock gained over 11% in 2011, falling slightly below the overall index returns of the Utilities Select Sector SPDR Fund ( XLU), which gained over 14% in 2011. Nevertheless, Pepco's 5.51% dividend yield significantly outpaced the Utilities Select Sector ETF's 3.96% yield.

Pepco Holdings is expected to earn 18 cents a share when it reports fourth quarter earnings on Feb. 24, according to Zacks consensus estimates. The company is expected to have revenue of $6.6 billion and net profits of $271 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $6.8 billion and $301 million, respectively.

Fitch notes that the company operates in four regulatory jurisdictions, all of which would have to approve any merger or takeover.

Analysts give Pepco Holdings an average price target of $21 a share, an over 7% premium to the company's current share price of $19.6. For more on Pepco's shares, see 6 stocks that will benefit from reverse migration .

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9. NV Energy

NV Energy ( NVE) is Fitch's second largest energy sector takeover candidate with a $3.76 billion market cap. The Reno, N.V. -based utility has six wholly owned subsidiaries that provide electricity to over 2.4 million state residents and an estimated 40 million Nevada tourists. The 150-year old company serves electricity customers in Las Vegas, Reno-Sparks, Henderson and Elko, N.V, and provides natural gas to an additional 145,000 Reno-Sparks customers.

NV Energy gained its statewide foothold through a July 1999 merger between Nevada Power, Sierra Pacific Power and Sierra Pacific Resources. NV Energy offers electricity and gas services under the names of those three units. The company's shares rose over 15% in 2011, beating the Utilities Select Sector SPDR Fund.

Fitch notes that the company operates in two regulatory jurisdictions, which would have to approve any merger or takeover.

The company is expected to earn 3 cents a share when it reports fourth quarter earnings on Feb. 21, according to Zacks consensus estimates. NV Energy is expected to have revenue of $3.2 billion and net profits of $200 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $3.3 billion and $285 million, respectively.

Analysts give NV Energy an average price target of $17.06 a share, a n over 5% premium to the company's current share price of $16.24. For more on NV Energy's shares, see 6 utility stocks to light up a portfolio .

Goldman Sachs, which sees the utilities sector significantly underperforming consensus estimates on falling energy and gas prices, rates NV Energy as one of only three "buy" rated regulated utility stocks. "We recommend owning small cap NV Energy given significant dividend growth coming in late 2012," writes Goldman analysts in a Jan. 16 research note that gives its utilities outlook for 2012.

The firm estimates that from 2010 through 2013, NV Energy will have a compounded annual dividend growth rate of 16%, among the highest in the sector

Currently, Goldman Sachs is 6% below 2012 consensus utilities earnings estimates and 3% below 2013 estimates because it assumes that diversified utilities will sell natural gas for $3.10 per MMBtu this year and at $4.25 MMBtu next year, well below the $5.50 MMBtu prices that utilities need for "normalized" earnings.

Utilities investors will need an especially long-term investment time horizon if they are to expect strong earnings, according to Goldman Sachs. Earnings will recover as coal plants get phased out, cutting energy supplies and giving natural gas more investable prices. "Power market fundamentals will eventually improve - but largely when coal retirements occur in the next 5-7 years," writes Goldman Sachs. For more on coal retirements, see why old king coal is heading to the retirement home .

In the meantime, Goldman Sachs recommends that investors seek value utilities stocks like NV Energy that are trading at low price-to-earnings ratios and with high dividend growth prospects.

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8. Westar Energy

Fitch sees regulated utility Westar Energy ( WR) as a potential takeover candidate in 2012 and beyond. The company currently has a market cap of $3.33 billion and a dividend yield of 4.51%.

Westar Energy is a Kansas passed public utility that has a vertical operation of electricity generation, transmission and distribution to roughly 687,000 customers in the state. While Westar Energy serves cities like Topeka, Lawrence, Manhattan, Salina and Hutchinson, K.S., it's Kansas Gas and Electric subsidiary serves south central and southeastern Kansas. The company's customers are split with roughly 369,000 being served by Westar, while 318,000 are served by KGE.

In 2011, Westar Energy slightly underperformed the sector index, posting an over 12% annual gain.

Fitch notes that the company operates in one regulatory jurisdiction.

The company is expected to earn 16 cents a share when it reports fourth quarter earnings on Feb. 23, according to Zacks consensus estimates. Westar Energy is expected to have revenue of $2.1 billion and net profits of $217.4 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $2.2 billion and $244 million, respectively.

Analysts give Westar Energy an average price target of $29.17 a share, a 3% premium premium to the company's current share price of $28.40. For more on Westar Energy's shares, see 8 high dividend utility stocks to watch.

Goldman Sachs analysts estimates Westar Energy will have a compounded annual dividend growth rate of 3% from 2010 through 2013, one of the 10 highest growth rates in its sector coverage.

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7. Great Plains Energy

Fitch rates Great Plains Energy ( GPX) with a $2.81 billion market cap and a 4.11% dividend yield.

Great Plains Energy is the holding company for Midwestern utilities Kansas City Power & Light and KCP&L Greater Missouri Operations Company, which combined serve over 800,000 customers in 47 Missouri and Kansas counties. The company's vertical operations generate 6,100 megawatt of electricity generation that are transmitted and sold in the region. From 2005 to 2010, the company embarked on a strategy to increase its energy generation and transmission by refurbishing existing facilities.

Fitch notes that the company operates in two regulatory jurisdictions, which would have to approve any merger or takeover.

The company is expected to earn 2 cents a share when it reports fourth quarter earnings on Feb. 27, according to Zacks consensus estimates. Great Plains Energy is expected to have revenue of $2.3 billion and net profits of $188 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $2.4 billion and $230 million, respectively.

Analysts give Great Plains Energy an average price target of $22.7 a share, an over 10% premium to the company's current share price of $20.67. For more on Great Plains Energy shares, see TheStreet Rating's portfolio of the highest yielding electrical utility stocks.

The company's shares gained 12.35% in 2011, slightly underperforming the sector index. Nevertheless, Goldman Sachs analysts highlight Great Plains Energy as one of its regulated utility stock recommendations because it trades at stock prices below its peers and historical earnings multiples on its expected 2013 earnings.

The firm also estimates Great Plains Energy will have a compounded annual dividend growth rate of 3% from 2010 through 2013, one of the 10 highest growth rates in its sector coverage.

Great Plains Energy Incorporated and Kansas City Power & Light also cut a high speed fiber optic internet service with Google ( GOOG) in May, making it the first investor-owned utility to partner with the Mountain View, Calif., based tech titan on its Google Fiber initiative.

In 2007, Great Plains Energy bought Aquila, a struggling Kansas-based utility for $1.7 billion in a cash and stock deal, gaining an added foothold in Midwestern states.

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6. IDACORP

IDACORP Inc. ( IDA), with a market cap of $2.08 billion and a dividend yield of 3.16%, is a regulated utility that could garner takeover interest, according to Fitch Ratings. The Boise, I.D. -based company operates through its subsidiary Idaho Power and conducts vertically integrated generation, transmission, distribution and purchasing of electricity.

Formed in 1988, IDACORP and its main Idaho Power subsidiary operate Idaho Energy Resources, a joint venture with Brigder Coal. The company also invests in real estate and affordable housing through its IDACORP Financial Services unit, and has a hydroelectric energy subsidiary called Ida-West Energy.

Fitch notes that the company operates in two regulatory jurisdictions, which would have to approve any merger or takeover. In addition, IDACORP is regulated by the Federal Energy Regulatory Commission.

The company is expected to earn 21 cents a share when it reports fourth quarter earnings on Feb. 29, according to Zacks consensus estimates. IDACORP is expected to have revenue of $1 billion and net profits of $169 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $1.2 billion and $153 million, respectively.

Analysts give IDACORP an average price target of $46.17 a share, an over 10% premium to the company's current share price of $41.83. For more on IDACORP shares, see TheStreet Rating's portfolio of the 3 volcanic energy stocks.

The company's shares gained over 14% in 2011, beating the sector index. On Jan. 20, the company boosted its dividend to 33 cents a share that will be payable on Feb. 29 for all holders of the company's shares on before Feb. 6.

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5. Portland General Electric

Fitch highlights regulated Pacific Northwest utility Portland General Electric ( POR) as a potential takeover target. Currently, the 124-year old company has a market cap of $1.87 billion and a dividend yield of 4.26%.

Portland, Or.-based company has vertical generation, purchase, transmission, distribution and retail sales operations in Oregon, serving 717,719 retail customers in addition to another 100,000-plus of commercial and industrial customers. According to is Web site, the company generates $1,049.03 in annual revenue per customer.

In 1997, now-defunct Enron bought Portland General Electric for $2 billion in stock and an additional $1.1 billion in debt. After Enron fell into bankruptcy, an investor consortium led by former Oregon Governor Neil Goldschmidt and private equity firm Texas Pacific Group tried to buy PGE out of the bankruptcy for $3 billion in a multi-year deal negotiation that broke down in 2005. The company instead opted to become independent and underwent an initial public offering in May of 2006.

Fitch notes that the company operates in just one regulatory jurisdictions, which would have to approve any merger or takeover.

The company is expected to earn 45 cents a share when it reports fourth quarter earnings on Feb. 24, according to Zacks consensus estimates. Portland General Electric is expected to have revenue of $1.85 billion and net profits of $151 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $1.9 billion and $145 million, respectively.

Analysts give Portland General Electric an average price target of $26.50 a share, an over 6.5% premium to the company's current share price of $24.88. For more on Portland General Electric shares, see the portfolio of investor David Dreman.

The company's shares gained over 16% in 2011, beating the sector index. Goldman Sachs analysts estimate that Portland General Electric will have a compounded annual dividend growth rate of 3% from 2010 through 2013, one of the 10 highest growth rates in its sector coverage.

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4. PNM Resources

Fitch rates PNM Resources ( PNM) as one of its potential takeover targets. The Albuquerque, N.M.-based company currently carries a market cap of $1.53 billion and a dividend yield of 2.84%.

PNM resources generates, transmits and distributes electricity and has operations for the transmission, distribution and sale of natural gas in New Mexico and Texas. The company also owns 50% of an unregulated utility in Texas called Optim Energy, which is covered by the Electric Reliability Council of Texas.

In Nov. 2011, the company sold its First Choice Power unit to Direct Energy for $270 million. With the funds, PNM looked to buy back shares and pay down debt, the company said in a statement.

Fitch notes that the company operates in just two regulatory jurisdictions, which would have to approve any merger or takeover.

The company is expected to earn 13 cents a share when it reports fourth quarter earnings on Feb. 15, according to Zacks consensus estimates. PNM Resources is expected to have revenue of $1.66 billion and net profits of $93.3 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales numbers are expected to fall to $1.4 billion, but profits will rise to $106 million.

Analysts give PNM Resources an average price target of $19.10 a share, an over 7% premium to the company's current share price of $17.81. For more on PNM Resources shares, see the portfolio of Cascade Investment Management, the investment vehicle for Microsoft co-founder Bill Gates.

In 2011, the company's shares gained over 36%, bolstered by the sale of its Texas business. Bernstein analyst Hugh Wynne highlighted PNM Resources as a potential takeover candidate because of its low valuation, in an Oct. 2011 research note.

Goldman Sachs analysts estimate that PNM Resources will have a compounded annual dividend growth rate of just 2% from 2010 through 2013, one of the laggards in its sector coverage.

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3. Avista Corp.

Fitch highlights Avista Corp ( AVA) as a potential regulated utility takeover target. Currently, the company carries a market cap of $1.46 billion and a dividend yield of 4.39%.

The Spokane, W.A -based utility has electricity generation, transmission and distribution operations through its Avista Utilities unit, which also distributes natural gas. The company also has a 76% stake in Ecova, an energy expense management service company that operates throughout the U.S. Ecova's main businesses is helping utilities and telecoms manage leasing arrangements, in addition to tracking energy and water use.

Founded in 1889 as the Washington Water Power Company, Avista got its present name through a 1998 name change.

Avista's utility serves customers with a mix of hydro, natural gas, coal and biomass generation that is delivered via over 2,100 miles of transmission lines and 17,000 miles of distribution lines to roughly half a million customers.

Fitch notes that the company operates in three regulatory jurisdictions, all of which would have to approve any merger or takeover.

The company is expected to earn 45 cents a share when it reports fourth quarter earnings on Feb. 15, according to Zacks consensus estimates. Avista is expected to have revenue of $1.6 billion and net profits of $101 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to $1.71 billion, but profits will rise to $105 million.

Analysts give Avista an average price target of $24.90 a share, a discount to the company's current share price of $25.28. For more on Avista shares, see TheStreet's portfolio of the highest yielding electric utility stocks.

In 2011, the company's shares gained over 14%, in line with overall sector returns. Bernstein analyst Hugh Wynne highlighted Avista as a potential takeover candidate because of its low valuation, in an Oct. 2011 research note.

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2. Black Hills Corp.

Fitch Ratings notes Black Hills Corp ( BKH) as a potential takeover target in coming years. Currently, the company has a market cap of $1.33 billion and it carries a dividend yield of 4.41%.

The Rapid City, S.D.-based company operates both a regulated utilities unit and a non-regulated energy business. Within its regulated utility unit, the company operates Black Hills Power and Cheyenne Light Fuel & Power, which combined serve over 100,000 customers in South Dakota and Wyoming. In 2007, the unit also bought a Kansas based gas and utility operation from struggling utility Aquila, which brought on gas operations in Colorado, Iowa and Nebraska for $940 million.

In addition, Black Hills operates an oil and gas exploration and production company that produces oil and gas in New Mexico, Wyoming and Colorado. It also runs a non-regulated wholesale natural gas & oil marketing and production company called Enserco Energy, and a coal mine in Wyoming's Powder River Basin called Wyodak. In October 2010, the company suspended operations at its 34.5-megawatt coal-fired Osage Power Plant in Osage, Wyo.

Fitch notes that the company operates in four regulatory jurisdictions, all of which would have to approve any merger or takeover.

The company is expected to earn 57 cents a share when it reports fourth quarter earnings on Feb. 2, according to Zacks consensus estimates. Black Hills is expected to have revenue of $1.3 billion and net profits of $76.1million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $1.42 billion, and $94 million, respectively.

On Jan. 18, the company lowered its 2012 earnings per share guidance to between $2 and $2.20 a share, but raised its 2011 EPS guidance to $1.90 - $1.96. In the announcement, Black Hills said it received "multiple unsolicited inquiries" for its Enserco unit in the third quarter.

Analysts give Black Hills an average price target of $34 a share, a small premium to the company's current share price of $33.59. For more on Black Hills shares, see the KJP 2012 Carbon Flash Fund portfolio.

In 2011, the company's shares gained over 11%, slightly below overall sector returns.

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1. Empire District Electric

Fitch Ratings highlights sub-$1 billion regulated utility Empire District Electric ( EDE) as a potential takeover target. The company has a market cap of $866.8 million and it currently has suspended its dividend.

Joplin, M.O -based Empire District Electric had to suspend its dividend in May after a category five leveled the city, killing 160 people and injuring nearly 1000 more, creating billions in damages.

The public utility generates, purchases, transmits, distributes and sells electricity in Missouri, Kansas, Oklahoma and Arkansas via its electricity and gas units. The 102 year old company serves nearly 170,000 electricity customers and an additional 44,487 gas customers.

Fitch notes that the company operates in four regulatory jurisdictions, all of which would have to approve any merger or takeover.

The company is expected to earn 20 cents a share when it reports fourth quarter earnings on Feb. 2, according to Zacks consensus estimates. Empire District Electric is expected to have revenue of $573 million and net profits of $57 million in 2011, according to Bloomberg consensus estimates. In 2012, those sales and profit numbers are expected to rise to $606 million and $58 million, respectively.

In May, the company suspended its 25 cent a share dividend for an expected two quarters. In 2010, the company paid out $1.28 in dividends, but has not yet announced a resumption.

Analysts give Empire District Electric an average price target of $22 a share, a 6.33% premium to the company's current share price of $20.69. For more on Empire District Electric's shares, see the portfolio of 8 high yield defensive stocks.

In 2011, the company's shares fell over 5%, recovering from a near 20% share drop in the days after the Joplin, M.O.-tornado.

In 2006, Empire acquired natural gas distribution rights from Aquila, expanding its Midwestern footprint.

-- Written by Antoine Gara in New York