BALTIMORE (Stockpickr) -- If you want to think like the "smart money," you've got to get boring. No, I'm not criticizing how hedge fund managers spend their weekends. Instead, it's all about what they're doing with their portfolios in 2014.
For instance, hedge funds piled into utility stocks in a big way last quarter, making it one of just four sectors that saw net buying from professional investors during the quarter. Normally, utilities fall in the category of "widow and orphan stocks" -- they're the staid dividend-paying names that don't pack many surprises. But in the context of 2014's flight to yield, they've been delivering anything-but-boring performance.
Since the calendar flipped to January, the average utility stock has delivered nearly 8% gains. That's double what the S&P 500 has paid you -- and that's not counting dividends.
But we're not talking about the average utility stock today. Instead, we're focusing on the five utility names that hedge fund managers love the most. To figure those out, we've got to take a closer look at 13F filings.
Institutional investors with more than $100 million in assets are required to file a 13F -- a form that breaks down their stock positions for public consumption. From hedge funds to mutual funds to insurance companies, any professional investors who manage more than that $100 million watermark are required to file a 13F.
In total, approximately 3,700 firms file 13F forms each quarter, and by comparing one quarter's filing with another, we can see how any single fund manager is moving their portfolio around. While the data is generally delayed by about a quarter, that's not necessarily a bad thing -- research shows that applying a lag to institutional holdings can generate positive alpha in some cases. That's all the more reason to crack open the moves being made with pro investors' $19.6 trillion under management.
Today, we'll focus on hedge funds' five favorite utility stocks.
First up is Exelon (EXC), a utility name that's been getting extra attention in the last few months thanks to a hungry acquisition strategy. Exelon was the most-bought utility stock by hedge funds last quarter, as pro investors picked up 15.98 million shares of the $32 billion company.
Exelon is a holding company that owns a collection of regulated and unregulated utility assets that includes 34 gigawatts of electrical generating capacity, and a distribution business that reaches more than 6 million electricity and gas customers in Illinois, Pennsylvania, and Maryland. Exelon's bid to buy Pepco (POM) in April would significantly increase the firm's exposure in Maryland around the nation's capital, a complement to the acquisition of Baltimore Gas & Electric's parent company back in 2012.
Exelon's generation mix is attractive right now. The firm generates approximately 20% of the country's nuclear power, giving it big exposure to a very low-cost source of energy. Likewise, its exposure to all corners of the utility market (from generation to distribution to retail to trading) makes it a well-diversified way to get exposure to utilities right now.
Income-seekers can rejoice too: with a dividend yield of 3.9% at current price levels, EXC remains a big payer right now. You could do a lot worse than following hedge funds into this name.
2014 has been a solid year for shares of NextEra Energy (NEE). Since the first trading session of this year, shares of the $42 billion utility stock have rallied 13.5%. And fund managers have been piling into this stock, buying 7.66 million shares in the last quarter alone. As we head into the summer months, there's reason to expect more of the same from NextEra.
NextEra is the incumbent power company in Florida, with its Florida Power & Light subsidiary providing regulated power to 4.5 million customers in the Sunshine State. It's also a mammoth non-regulated merchant generation firm, with 42.5 gigawatts of generation capacity spread across natural gas, wind, solar and nuclear assets. One of NEE's most interesting characteristics is its huge wind and solar portfolio. While both technologies are arguably still in their early stages, NEE has been able to collect big incentives for generating significant renewable energy (at a low ongoing cost), and investors have benefitted from that exposure. Renewable generation also decouples NextEra's margins from commodity prices, a very tangible benefit if price inflation begins to squeeze competitors again.
The utility business is extremely capital-intense, but NextEra's $23 billion debt load is manageable -- especially in this low-rate environment. Finally, NEE's net profit margins are substantial. The firm consistently converts more than 10 cents of every dollar it earns into earnings, an impressive level of profitability for a utility stock. Right now, NEE pays a 3% dividend yield.
$18 billion utility stock Edison International (EIX) is next up on hedge funds' "buy list" -- funds picked up 3.23 million shares of the California-based electric utility last quarter. EIX is the holding company for Southern California Edison, which powers around 14 million residents in the area surrounding Los Angeles.
After years of drama, Edison's merchant generation arm filed for bankruptcy last year, prompting a sale of the unit to NRG Energy (NRG). Unloading that non-regulated business concentrates the good side of EIX: the regulated power company. Without the huge commodity risks and the pressure from a soft electricity market, Edison is free to increase the quality of its earnings in 2014. Because Edison operates in a geographically attractive region where electricity demand is high and supply is limited, the firm should be able to generate stable growth by continuing to build out its infrastructure.
That doesn't mean that Edison will completely ignore non-regulated side businesses going forward. Management has said in the past that they want to retain diversification. But this time, they'll do it through smaller efforts rather than a single large generation unit. For now, EIX is one of the more stable utility names you can pick up.
Dominion Resources (D) is an electric utility with a natural gas bent. The firm owns 27.5 gigawatts of generating capacity and around 63,000 miles of electric transmission lines, but it also sports 950 billion cubic feet of natural gas storage capacity, enough to make it one of the largest natgas storage plays on the market. Dominion's retail business serves approximately 6 million customers in 15 states.
In the past decade, Dominion has done what a lot of its savvier peers have. It's dramatically reduced exposure to its unregulated businesses, instead acquiring regulated assets to boost its defensive cash generation. There's good reason why regulators are Dominion's friends: in the areas where the firm operates, regulatory agencies have traditionally been quick to approve rate hikes as Dominion's costs go up, giving the firm an extremely low-risk source of moderate returns. The firm's natural gas exposure makes Dominion unique, especially because as a storage system and gas utility, it's mainly exposed to nat gas volume, not the price of the commodity itself.
Institutional investors picked up 600,720 shares of Dominion last quarter, a stake worth approximately $43.6 million at current levels. While that's not a huge number on an absolute basis, it's a pretty big buy in the context of the quarter we just closed, where funds were net sellers of stocks.
Last up is Southern Company (SO), a utility stock whose main business is focused on the Southeastern states, serving more than 4.4 million customers spread across Alabama, Georgia, Florida and Mississippi. The firm also owns more than 45.7 gigawatts of generating capacity and a merchant generation business.
Like Dominion, Southern operates in a region that's traditionally friendly to businesses. That means that regulatory are quick to provide rate hikes when Southern's cost of delivering power increases. One detractor at Southern is the fact that a large portion of the firm's generation portfolio comes from coal, which continues to face environmental rules that could be costly. To combat that, Southern has been undertaking a large investment in retrofitting existing coal plants for lower emissions -- or phasing coal power plants out entirely.
At the end of the day, it's Southern's relationships with regulators that make it stand out. The firm's low cost lag means that it's able to pass more cash onto shareholders in the form of dividends -- and the payouts are big. At current levels, SO pays a hefty 4.8% yield...
Fund managers like the income too. Last quarter, they bought 20.15 million shares of Southern.
To see these stocks in action, check out the Institutional Buys portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.