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Utility funds: The duller the better
After years of trying to make a bundle doing everything but generating electricity, power companies are going back to basics. That makes these funds safe bets again.
By Timothy Middleton
There's a way you can make a buck on the great blackout of 2003. Its just a little complicated.
The response to the calamity has been a lot of finger-pointing, but not a single serious proposal actually to do something about it. Thats because nobody can. The Federal Energy Regulatory Commission is hamstrung by the not-in-my-backyard folks.
It took American Electric Power (AEP, news, msgs) 10 years to win approval for the construction of 90 miles of transmission lines in Virginia. At that rate, FERC will eradicate blackouts during the presidency of George Bush CXXIX.
But you can safely ignore the tumult, assuming youve got candles and batteries, because deregulation has finally shaken out the losers, which is just about any company involved in transmission, and taught the survivors how to behave.
The widows-and-orphans role
Companies are in the return-to-basics mode, says Larry Alberts, co-manager of AXP Utilities Fund (INUTX). They're abandoning their doomed attempts to become growth stocks and returning to their widows-and-orphans role.
Alberts fund yields about 4%. Franklin Utilities (FKUTX) delivers 5.1%. Dividends are on the road to resuming their primacy in stock investing. In todays muddled investment world, getting a bond-size return with at least some equity upside sounds old-fashioned, in the good sense of the term.
The power business can be viewed as a dumbbell, with generating plants at one end and distribution, or local power lines, at the other. The pole in between is transmission, which crosses state lines.
The two bells are regulated by the states, for dumb or dumber. Montana has gone from low electric prices to high, and Montana Power into various stages of bankruptcy. Its utility commissioners are elected.
In most states, regulators allow utilities to make at least some money. The largest holding of AIM Global Utilities Fund (AUTLX) is FPL Group. (FPL, news, msgs), which has managed to generate enough current to pay a dividend of 3.8%.
Back to the basics
Jeff Morris, manager of the AIM fund, says electric utilities by and large are getting back to generating and distributing power. Transmission, the weak link in the industry, is a stepchild of these companies.
(These funds also invest in telephone utilities, but to a lesser degree -- less than 10% of Franklins assets, for example.)
The companies are focused on rationalizing their businesses, says Bob Becker, the Franklin fund's co-manager. Theyve abandoned their dreams of lofty P/E ratios.
Those dreams included turning their rights of way into the information superhighway; Montana Powers subsidiary in that line is in Chapter 11 bankruptcy proceedings. Their dreams also included trading power in a robust national market; Enron ended that.
One of Franklins largest holdings is Exelon (EXC, news, msgs), the merger of Commonwealth Edison and PECO Energy. It largely shuns the transmission business, meaning its regulated and future cash flows are becoming more predictable. Its also slashing costs by $600 million a year.
Lean times
Joseph Schumpeter called creative destruction the essential fact about capitalism. Deregulation was supposed to unleash it, but regulation is producing profits. The most successful utility investments have been heavily regulated businesses content to stay that way.
They were not successful in the 1990s. The average utility mutual fund eked out a 5.1% annualized gain over the last 10 years, dragged down by a 1.6% loss over the last five years. The Franklin fund, though, has earned 3% a year since Becker and co-manager John Kohli took over five years ago.
Becker says he thinks the group is beginning to look attractive. Multiples have returned to their usual level, about a third less than stocks, in general, because utility earnings growth is a plodding 3%. Failing companies are being shaped up or shipped out. Commonwealth Edison has new management at Exelon. NorthWestern (NOR, news, msgs), parent of Montana Power, is 62 cents, the price of its stock, away from Chapter 11.
Utilities are a dull story. But dull is better than being broke. Even bond investors have been jolted by losses lately. Electric utilities have already had theirs.
Excitement was bad for power companies. Dull is good. Excitement was bad for equity portfolios, too. A dose of dull isnt likely to hurt them in coming years, and could actually help.
What they're buying now
A bargain: Becker says Exelon (EXC, news, msgs) is also a good value play. The stock trades at a multiple to forward earnings of 10.7, compared with an industry average of 12.7. Part of the problem is Commonwealth Edisons lousy reputation in the business, but at Exelon, the chief executive, chief financial officer and chief operating officer all are new. We like the management, Becker says.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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