Few sectors are more defensive or less sexy than electric utilities. Sure, everyone needs electricity, but government regulation limits what management can do, especially when it comes to prices. And while the S&P 500 ($INX) has climbed nearly 14% in the last 52 weeks, the broader utility sector gained just 5.6%. Indeed, only health care lagged the market by a greater amount.
Still, electric utilities throw off healthy dividends, making them ideal for investors looking for a steady income stream, and their low betas mean they are far less volatile than the S&P 500. When Duke Energy's (DUK) recently inked a deal to buy Progress Energy (PGN) for $14 billion, creating the largest U.S. utility, it injected a bit of, er, electricity into an otherwise boring business. That got us thinking about electric utility stocks -- and whether there might be some bargains hiding in the wiring. Here's what we found.
American Electric Power (AEP) is the second-largest generator of electricity and the largest transmission system owner in the country. Shares have been essentially dead money over the last year, but that's helped keep the relative valuation reasonably attractive on a trailing and forward earnings basis. The dividend yield of 5.2% is mighty tempting, too. On the other hand, the company generates most of its power using coal, prices of which are rising amid the devastating floods in Australia. Furthermore, the weak recovery here at home has has weighed on near-term earnings, cash flow and dividend payments.
Constellation Energy (CEG) has been a money-losing investment over the last year but shares have rebounded sharply since bottoming out in mid-December. The diversified utility has commodity exposure in its customer supply and power generation businesses, which generate the bulk of profits, and now that energy prices are soaring again, so, too, could this stock. Underperformance has made the relative valuation look like a deep bargain, and even after slashing its dividend a year ago, Constellation yields 3%. On the other hand, commodity exposure makes it more volatile than peers as well as the broader market.
Allegheny Energy (AYE) has had a solid run over the last 52 weeks, nearly matching the gains of the broader market while being significantly less volatile. Shares look compellingly valued on a trailing and forward earnings basis, despite the decent run in the stock price. On the other side of the ledger, the dividend yields only 2.4% at current levels, and, as Morningstar analyst Mark Bennett has noted, the company's exposure to market power prices, coal costs and an outstanding friendly takeover bid from FirstEnergy (FE) "all inject uncertainty into its prospects."
For the bull and bear cases on American Electric Power, Constellation Energy and Allegheny Energy, see Face-Off on Stocks above.
Learn the most important step in structuring an investment portfolio.View Course »