2 Undervalued Utilities to Profit From Interest Rate Fears

NEW YORK (TheStreet) -- The Federal Reserve is widely expected to increase interest rates this year, but so far, it has not yet acted. The International Monetary Fund recently warned against prematurely raising interest rates, saying it believes the Fed should hold off until at least the first half of 2016.

The IMF is not the only organization concerned about premature rate increases. An account of the April Federal Reserve meeting shows that the chairwoman Janet Yellen and other Federal Reserve members are still concerned about the lower-than-expected pace of growth. As a result, they have not yet increased interest rates.

Inactivity from the Federal Reserve has not stopped speculation about rising interest rates. Despite current fears, rising interest rates will not break dividend stocks. The market has overreacted - and acted prematurely. Utility stocks specifically have seen price declines. When markets overreact, savvy investors can purchase shares at a discount. This article covers 2 utility stocks with dividend yields over 4% that appear undervalued at this time.

First Energy Corporation

First Energy (FE) provides electrical utility services to more than 6 million people in Ohio, Pennsylvania, West Virginia, New Jersey, Maryland and New York. The company generates 44% of its electricity from coal plants, 26% from nuclear plants, and purchases the other 30%.

The company has struggled in 2013 and 2014. It had to cut dividends from $2.20 per share in 2012 to $1.65 per share in 2013, and $1.44 in 2014, due to an underfunded pension and weakness in the company's unregulated business.

Going forward, First Energy should see steady or rising dividends. The company is focusing on its steady, profitable regulated utilities business, rather than its unregulated business, which it will likely sell within the next several years if a suitable buyer can be found. First Electric has already booked sizable expenses bolstering its underfunded pension. The pension situation should not impact earnings going forward.

Fears of rising interest rates have pushed First Energy Corporation's share price down in recent months, from a high of over $40 per share at the beginning of 2015 to $34.51 a share on Thursday.

First Energy Corporation is currently trading for a forward price-to-earnings ratio of just 12.9. First Energy has the lowest forward price-to-earnings ratio of any large cap United States based electric utility provider. The company's peer group has an average forward price-to-earnings ratio of 15. First Energy Corporation appears undervalued relative to its peers at current prices.

Despite the recent dividend cuts, First Energy Corporation still has a high 4.2% yield. Investing in high-yield stocks with low valuation multiples allows investors to get "paid to wait" for the stock to return to fair value.

SCANA Corporation

Like First Energy, SCANA  (SCG) has seen its share price tumble in 2015 due to fears around rising interest rates. The company's share price has fallen from highs above $64 to $51.39 over the last 5 months.

SCANA is an electric and gas utility provider with a market cap of $7.4 billion. It provides electricity utility services to 692,000 customers in South Carolina as well as gas utility services to 1.3 million customers in North Carolina, South Carolina and Georgia.

SCANA is consistent. The company has paid steady or increasing dividends (excluding spin-offs and acquisitions) every year since 1987. It's one of the few businesses that meet the first criterion in The 8 Rules of Dividend Investing; It has 25 or more consecutive years of dividend payments without a reduction.

The company focused its operations on its regulated utilities businesses in 2014, when it sold both its gas pipeline and telecommunications divisions. SCANA used the proceeds of these sales to offset share dilution from capital spending on new growth projects.

SCANA is projecting 3% to 6% growth in earnings per share over the next five years. Dividends will likely grow at a similar pace. The company's growth will come from incremental organic growth of 2% to 3% a year combined with large projects. SCANA is currently building (in conjunction with a state owned utility) two 1,117 megawatt electricity-generating nuclear stations in Fairfield County, S.C. Large projects will add additional earnings growth for the company.

Shareholders can expect total returns of between 7% to 11% a year from SCANA from the company's 4.2% dividend yield and earnings-per-share growth of around 3% to 6% a year. SCANA is currently for a forward price-to-earnings ratio of just 13.3. Mid-cap U.S.-based electrical utility companies have an average forward price-to-earnings ratio of 16.6. SCANA is undervalued relative to its peers, despite its long history of rewarding shareholders with rising dividends.

 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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