Utility stocks can best be described as the four-door, mid-sized sedan of equity investing: boring. Nothing sexy about them -- they get you from point A to point B. Investors own utilities for the steady, above-average dividends just as people buy bland, mid-size sedans because they need something that just works.
But sometimes both can seem overpriced. In 1987, the base price of a new, Honda Accord was around $9,795. Today, that base price is around $22,455, which implies an annual price increase of 4.3%; 33.5% more than the average annual inflation rate of 3.22% for the same time period. So, while that mid-sized sedan may still seem like a bargain, it's gotten slightly more expensive over the longer haul.
Utility stocks also outperformed inflation during a similar run. The average yield of utility stocks over the last 25 years has been 3.96% while inflation has averaged around 2.11% for the same period. Over the long haul, dividend paying-utility stocks delivered exactly what they should which is to keep pace with inflation.
But sometimes utility stocks, like that boring sedan, can look expensive. The sector has been dealing with this recently.
After a post-election dip that coincided with a significant short-term move in treasury yields (utility stocks are ALWAYS interest rate sensitive), their prices have recovered to last year's highs.
Investors looking to add quality utilities to their portfolios are challenged to find real value in the space. Here are three names I've found that fit the bill.
Entergy Corporation (NYSE: ETR)
With over 30,000 megawatts of aggregate generating capacity, Entergy's footprint covers Arkansas, Texas, Mississippi, and its home state of Louisiana. On a forward P/E basis, the stock trades at an attractive discount relative to its peer group. According to current research from Yardeni and Associates, S&P 500 members in the utility sector trade at an average forward P/E of 17.5. Entergy shares trade at a forward P/E of 15.6, a discount of nearly 11%.
National Grid Plc (NYSE: NGG)
Headquartered in the UK, National Grid focuses on electricity and natural gas distribution in the United Kingdom and the northeastern United States. Again, the LNG export story plays in. The company has also been ramping up LNG storage capability in the UK just as U.S. exports begin to ramp up.
On a fundamental basis, there's also a growth story in NGG's earnings per share (EPS). Full year 2016 EPS grew at a 21% clip year-over-year, coming in at $3.60 versus 2015's result of $2.97. 2017 revenue forecasts call for a 7% increase over 2016 which could also pave the way for an upside earnings surprise. At $69, shares trade at a 15% discount to their 52-week high and pay a 4.3% dividend yield.
Gabelli Utility Trust (NYSE: GUT)
Diving back into the closed-end fund pool (see my previous article), the Gabelli Utility Trust has long been a standby as a convenient solution for utility stock exposure and income. 40% of the fund's top holdings are in the electrical generation and distribution space, while natural gas, telecom, and cable round out the rest.
While shares trade at a premium to their net asset value (NAV), the fund's lowish price point, historically high yield, and historic outperformance (9.1% annually over the last 15 years versus the S&P 500's 7.51% for the same period), make GUT a good choice for investors seeking a basket-of-stocks approach. Shares currently trade around $6.80 with an attractive 8.9% yield.
Risks To Consider: Collectively, the biggest risk facing all three are, of course, rising rates. Traditionally, utility companies have always relied on debt financing for expansion and operation as their steady, predictable cash flow is typically sufficient to offset debt service. Higher borrowing costs are always a threat to consistent dividend payments.
This goes double for GUT in that the fund manager employs leverage to juice up returns and yields. Again, higher borrowing costs squeeze profits and reduce what the fund can pay out to shareholders. But while interest rates have moved up noticeably, they still have a long way to go before they reach a level at which they become problematic to equity investors.
Action To Take: Combined, these three stocks offer investors a blended yield approaching 6%. The inclusion of a closed-end fund offers additional diversification. With cooperative market conditions, upside of 9% to 10% over the next 12 months seems reasonable. Throwing in a 6% yield would result in a total return of 15%.
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