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Jan. 31, 2016, 6:00 p.m. EST

Escape the stock market rout with these utility stocks

Regulated electric utilities have a built-in defense mechanism

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By Philip van Doorn, MarketWatch


Scott Olson/Getty Images
Analysts at Jefferies expect shares of Exelon to rise 24% over the next 12 months.

Take a guess: Which U.S. stock sector has performed best so far this year?

Here’s your answer:

S&P 500 sector Total return - 2016 Total return - 2015
Utilities 0.3% -8.4%
Telecommunication Services -3.1% -1.7%
Consumer Staples -4.4% 3.8%
Health Care -7.2% 5.2%
Industrials -8.4% -4.7%
Consumer Discretionary -8.6% 8.4%
Energy -8.8% -23.6%
Information Technology -9.0% 4.3%
Financials -10.3% -3.5%
Materials -11.9% -10.4%
S&P 500 -7.9% 1.4%
Source: FactSet

That’s right: The boring utilities sector of the S&P 500 Index /zigman2/quotes/210599714/realtime SPX -0.11% is up slightly this year (through Friday), with dividends reinvested, while all the other sectors are down significantly.

Of course, it’s never a good idea to “chase performance.” But there’s a reason that investors are comfortable with their electric utility stocks during what seems to be shaping up as a year of fear.

“We believe that with low power prices and a weak natural gas forward curve, combined with market uncertainty and potentially rising interest rates, large-cap regulated [utilities] provide a quality return with relatively low risk,” Jefferies Group analyst Anthony Crowdell wrote in a report Tuesday.

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Utility stocks are considered to be dividend plays, with investors expecting moderate and steady earnings growth supported by state and local contracts. This means that your safest plays might be companies that derive most of their income from the regulated distribution of electric power to retail customers. The volatility of energy prices can make things pretty rough for utilities focused on selling generated power to wholesale customers.

Read: 10 oil companies that will thrive as crude prices rebound

Crowdell’s colleague Paul Fremont summed up the advantage for the regulated companies in an interview in May 2014: “[I]n most states there are fuel and purchase-power-adjustment clauses that automatically adjust prices.”

Crowdell believes 3% to 5% earnings per share growth and reliable dividend payments will be seen as “superior attributes in a market with questionable dividends and uncertain growth rates.”

Jefferies’ electric-utility picks

Here are the six electric-utility stocks with “buy” recommendations from Crowdell and his team:

Company Ticker Closing price - Jan. 15 Jefferies’ price target Implied 12-month upside potential Dividend yield
American Electric Power Co. /zigman2/quotes/209801263/composite AEP $58.69 $66.00 12% 3.82%
Exelon Corp. /zigman2/quotes/205982254/composite EXC $27.46 $34.00 24% 4.52%
FirstEnergy Corp. /zigman2/quotes/201870541/composite FE $31.83 $35.00 10% 4.52%
PG&E Corp. /zigman2/quotes/202583141/composite PCG $52.47 $59.50 13% 3.47%
PNM Resources Inc. /zigman2/quotes/202534367/composite PNM $30.20 $33.00 9% 2.91%
PPL Corp. /zigman2/quotes/207772352/composite PPL $33.29 $37.50 13% 4.54%
Sources: Jefferies, FactSet

Even though investors fear rising interest rates, which helped cause an 8.4% decline for the S&P 500 utilities sector in 2015, Crowdell said “investors should not be overly concerned with interest rates.”

He added that utility stocks have traded at similar valuations to earnings during times of higher interest rates. “The uncertainty seen in the markets is a positive for regulated utilities that outweighs interest-rate risk. Furthermore, even if interest rates rise, dividends are safe, as utilities are able to pass on higher interest expenses, albeit with some lag, to ratepayers,” he said.

Highest-yielding U.S. electric utilities

There are 28 large-cap utilities (with market values of at least $5 billion) included in the S&P 500. Here are the 10 with the highest dividend yields:

Company Ticker Dividend yield Closing price - Jan. 15 Consensus price target Implied 12-month upside potential Share of analysts with ‘buy’ ratings
CenterPoint Energy Inc. /zigman2/quotes/206368471/composite CNP 5.72% $17.30 $19.96 15% 38%
AES Corp. /zigman2/quotes/209256253/composite AES 5.15% $8.54 $11.85 39% 64%
Entergy Corp. /zigman2/quotes/208005291/composite ETR 4.99% $68.09 $72.39 6% 8%
Southern Co. /zigman2/quotes/208000495/composite SO 4.60% $47.17 $46.83 -1% 5%
Duke Energy Corp. /zigman2/quotes/201480230/composite DUK 4.58% $72.08 $76.20 6% 32%
PPL Corp. /zigman2/quotes/207772352/composite PPL 4.54% $33.29 $36.06 8% 55%
FirstEnergy Corp. /zigman2/quotes/201870541/composite FE 4.52% $31.83 $35.68 12% 42%
Exelon Corp. /zigman2/quotes/205982254/composite EXC 4.52% $27.46 $33.61 22% 62%
Pepco Holdings Inc. 4.13% $26.17 $25.50 -3% 0%
Public Service Enterprise Group Inc. /zigman2/quotes/201831904/composite PEG 3.94% $39.60 $41.78 5% 10%
Source: FactSet

Exelon Corp. announced an agrement to acquire Pepco Holdings Inc. in April 2014, and the deal was expected to be completed last year. However, the companies continue to face resistance to the merger .

If you are looking to make a long-term investment in a utility company for income, it’s important to do some reading to understand just what you are buying. A high dividend yield might mean the yield was driven up by a harsh price decline. A focus on the regulated retail electricity distribution business is important in a volatile market.

Also see: 10 dividend stocks for safe income as interest rates rise in 2016

/zigman2/quotes/210599714/realtime
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US : U.S.: NYSE
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US : U.S.: NYSE
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Rev. per Employee
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/zigman2/quotes/207772352/composite
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$ 29.13
+0.12 +0.41%
Volume: 2.37M
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P/E Ratio
62.48
Dividend Yield
5.70%
Market Cap
$22.42 billion
Rev. per Employee
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/zigman2/quotes/201870541/composite
US : U.S.: NYSE
$ 37.75
+0.52 +1.40%
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Dividend Yield
4.13%
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Philip van Doorn covers various investment and industry topics. He has previously worked as a senior analyst at TheStreet.com. He also has experience in community banking and as a credit analyst at the Federal Home Loan Bank of New York.

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