Week 259 - Barron’s 500 Utilities

Situation: You’ve been here before. We like utility stocks as bond substitutes. They grow, albeit slowly, giving investors some protection against the risk posed by rising interest rates. On the downside, utilities are a “crowded trade” because persistently low interest rates continue to drive investors away from bonds. If you’re migrating away from a 50:50 allocation for bonds and stocks, you’re probably targeting 60% stocks and 40% bonds. That means you’ll need to hold sizable positions in several utility companies, or an Exchange Traded Fund (ETF) for utilities such as iShares US Utilities ETF (IDU at Line 19 in the Table). Be aware that variable costs are high for these companies because of extensive maintenance requirements that exceed depreciation allowances. On the other hand, they are monopolies that benefit from state and Federal regulations which lower borrowing costs and ensure that customers will pay a fair price for utility services.

Mission: Provide a capsule summary for investors in Utilities. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Exclude any company that does not have an S&P bond rating of BBB+ or better, and an S&P stock rating of B+/M or better. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).

Execution: see Table.

Bottom Line: The numbers in the Table reflect high returns and low risk from investing in utility companies. However, this is partly because eight yrs of “monetary easing” has made bond-like stocks more valuable by pushing investors away from buying bonds. Prices for the group of 10 stocks in the Table are than 30% higher than can be justified by their earnings and book values (compare Columns T and U in the Table).

Risk Rating = 4 (Treasuries = 1 and gold =10)

Full Disclosure: I dollar-average into NEE.

NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 16 in the Table). Metrics highlighted in green at Columns P and Q indicate improving performance in fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA indicate a company in current difficulty, ROIC being lower than WACC.

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