Best Opportunities in a Bear Market

When the market opened on Oct. 26, Piedmont Natural Gas Company’s (NYSE: PNY) shareholders discovered that their positions had increased in value by 40 percent, thanks to a $60-per-share takeover offer from Duke Energy Corp (NYSE: DUK).

This deal came after AGL Resources (NYSE: GAS) accepted a similar takeover bid from Southern Company (NYSE: SO) that amounted to a 36 percent premium.

And there’s still money to be made by betting on utility mergers and acquisitions, even in the latter stages of this bull market.

In addition to gas utilities, cable television has emerged as another hot spot of deal flow as companies seek to add scale, with Cablevision Systems Corp (NYSE: CVC) and Time Warner Cable (NYSE: TWC) receiving takeover offers at high premiums.

Investors salivating over the prospect of windfall profits from picking the right takeover target should remember to focus only on names that have what it takes to generate compelling returns even if they remain independent.

With the search for scale fomenting an urge to merge in the telecom sector, investors will be hard-pressed to find any worthwhile holdings that trade at reasonable valuations.

Potential takeover targets among gas utilities have also been bid up to frothy valuations; Atmos Energy Corp (NYSE: ATO), for example, has surged 20 percent since Southern Company announced its agreement to acquire AGL Resources.

The run-up in these stock prices reflects the premiums paid in these recent deals. Duke Energy agreed to pay more than 30 times the midpoint of Piedmont Natural Gas’ earnings guidance for its fiscal year ending Oct. 31, 2016. Meanwhile, Southern Company’s takeover bid amounts to 23 times the consensus estimate for AGL Resources 2015 earnings per share.

Duke Energy and Southern Company paid top dollar in these deals because of the targets’ strategic value. The overlap between the electric and gas utilities’ service territories creates ample opportunity for synergies, especially with access to and demand for inexpensive natural gas expected to increase in the South.

Duke Energy and Southern Company find themselves on the ground floor of this change, as both electric utilities retire coal-fired power plants and add to their fleets of gas-burning facilities.

Neither electric utility would have paid as much for a gas utility outside its geographic footprint.

Would Pinnacle West Capital Corp (NYSE: PNW), which owns the Arizona Public Service Company, take a page out of Duke Energy and Southern Company’s playbooks and pay a similar premium for Southwest Gas Corp (NYSE: SWX)? Only time will tell.

WGL Holdings (NYSE: WGL) trades at almost 30 times trailing earnings without a deal on the table, while Conservative Income Portfolio holding New Jersey Resources Corp (NYSE: NJR) trades at 24 times earnings.

All these companies boast high-quality franchises, but investors have bid their stocks up to frothy valuations relative to what we would consider fair value, giving investors an opportunity to take at least some profits off the table. That’s why we cashed out of WGL Resources for a 66 percent gain on Oct. 21.