It's Time to Rethink Your Utility Holdings
Lexenberg, Stan, Medical Economics
There's news about utility investments, and it isn't good. The fact that there's any news about utilities is news in itself. The staid industry has quietly delivered double-digit returns with a minimum of risk for a decade. But humdrum days may be fading. Utility prices began falling last year. Analysts warn investors to prepare for an era of modest returns and growing risks.
Part of the problem stems from rising interest rates. When rates go up, prices of utility stocks drop as investors flee in search of higher yields.
But the trouble with utilities goes deeper than the latest rate increase imposed by the Federal Reserve Board. After deregulating airlines and savings and loans, Washington is turning its sights on utilities. And that's frightening news to the people who use utility stocks for their retirement plans or as ballast for their personal portfolios.
The regulators have removed some of the shelters that protected gas and electric companies from the cold winds of the free markets. Already big industrial customers have begun demanding price breaks and searching for low-cost power sources.
That's starting to pressure earnings of electric utilities. In the future, price wars could erupt.
Along with deregulation, the government has taken other steps to make life harder for utilities. Officials from the President on down have been preaching the value of conservation. They've provided incentives to make factories and homes more energy-efficient. That may be good for the planet, but it limits the growth of utility sales and earnings.
Does all the negative news mean you should dump your longtime utility holdings? Not necessarily. Utilities now yield an average of more than 6 percent, hardly chump change. And on top of the yield, analysts say, certain stocks could produce capital gains.
But as deregulation unfolds over the next decade, utilities may be separated into winners and losers. By holding winners, you should achieve respectable returns. If you select laggards, be prepared for red ink. Here are some promising stocks and mutual funds.
For steady long-term results, many analysts favor utilities that seem to be able to maintain above-average dividend growth. Such companies should shine even if the overall industry produces lackluster results.
Over the next five years, analysts expect industry dividends to increase by only 2 percent a year, down from the 4 percent rate of the late 1980s.
To collect dividend checks that will rise like clockwork, buy Entergy, suggests Mark Luftig, a utilities analyst for Kemper Securities. The Louisiana electric utility yields almost 6 percent, and Luftig expects the payout to rise by 5 percent year over the next several years.
The company has plenty of cash to cover its dividend, as demonstrated by the payout ratio--the percentage of earnings that go to dividends. While the industry devotes an average of 79 percent of its earnings to dividends, Entergy paid out only 61 percent last year. Furthermore, Entergy's recent merger with Gulf States Utilities should reduce costs as the two units end duplication and achieve economies of scale.
William Tilles, a utility analyst for Dean Witter, likes TECO Energy, a Tampa company with a long record of rising dividends. The stock yields about 5 percent, and Tilles expects the company to raise the payout by more than 5 percent a year over the long term. With the stock's payout ratio at only 68 percent, that prospect seems bright.
TECO should thrive under deregulation. It has begun moving into businesses, such as coal mining, that can produce higher returns than its regulated utility business. While the company expands outward, it has little cause to worry about defending its own turf from poachers. The Florida peninsula is guarded on three sides by the sea, and, says Tilles, "You can't build transmission lines through the Everglades. …