Accrued Interest: FIVE UTILITIES STOCKS TO CONSIDER

Monday, June 17, 2013

FIVE UTILITIES STOCKS TO CONSIDER

Recent selling off of utilities stocks may be presenting investors with a good opportunity to entry into the sector.

As Gary Cheng reports, Utilities stocks as represented by the Utilities Select Sector SPDR ETF (XLU) have fallen out of favor lately since the share price peaked in late April. The sector ETF has dropped 5.5% in the past four weeks and 10% since its late April peak, making it the worst-performing sector year-to-date. The interest rate sensitive sector is pulling back hard as investors speculate that the Fed may begin to taper its QE3 stimulus program and long-term interest rates begin to rise. Valuation of the group as a whole had also gotten fairly expensive relative to the market and remains pricey at 18.7 times trailing earnings while the sector's earnings are expected to grow just 3% - 5% per year, which is far below the 11% expected earnings growth for the S&P 500 Index.

The economic data released by the government in the past few months supports the notion that the economy is recovering at a slow and steady pace with gains seen in job creation and housing activities. Cheng expects the same pattern emerging in the next few months unless the Fed surprises us with a much earlier tightening time line. There will also be continuing talk about the premature end of the Fed's QE3 program, which will likely further pressure utilities stocks and XLU share price may have additional 5% downside until it reaches a stronger long-term trend line support at around the $35 - $36 level.

It's understandable that some investors may want to shun the utilities stocks altogether in an uncertain interest rate environment. Rather than totally avoiding this sector, Cheng believes investors should tilt their utilities stock allocation to those names that have good fundamental characteristics and can benefit from a steadily improving economy. Based on data compiled from YCharts.com, Cheng feels that the regulated electric utilities as a group has the best fundamental characteristics in the utilities sector, particularly in lowest debt-to-equity ratio, lowest interest rate on debt, highest cash flow from operations, positive free cash flow, and reasonable valuation at 16.3 times trailing earnings. The electric group was also the only group among the utilities sector to post year-over-year growth in the most recent quarterly revenue.

After careful analysis, Cheng has chosen five companies with solid fundamentals, stable dividend growth, and below market valuation multiples that he feels investors should further examine.