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Issues

The ETF Effect

By Roger S. Conrad on Apr. 12, 2016
Morningstar (NSDQ: MORN) recently reported that 247 mutual funds suffered outflows of at least 10 percent over the past year, with 18 losing more than 40 percent of their assets under management. Redemptions on this scale usually occur toward the end of a bear market, when many investors throw in the towel. This hemorrhaging stems from the growing belief that passive investment strategies involving exchange-traded funds (ETF) will outperform an active management over the long haul. Lower fees also help to bolster overall returns. Of course, ETFs and other products that offer one-stop exposure to a particular sector or theme often weight their positions by market capitalization. Utilities Select Sector SPDR (NYSE: XLU), for example, rebalances its holdings quarterly and exhibits a bias toward stocks that have already run up. At last check, NextEra Energy (NYSE: NEE), which trades at a record 21 times trailing earnings, accounted for 9 percent of the ETF’s portfolio. And the instant diversification offered by ETFs mean that you’ll always own the good, the bad and the ugly, which dilutes the best performers’ contribution. But discriminating investors can take advantage of the rise of ETFs.  

A Little Growth Goes a Long Way

By Roger S. Conrad on Mar. 10, 2016
Last Week, the US Dept of Energy’s Advanced Research Projects Agency (ARPA-E) held its annual Energy Innovation Summit in Washington, DC. Senate Energy & Natural Resources Committee Chairwoman Lisa Murkowski (R-AK), former Vice President Al Gore and Dept. of Energy Secretary Ernest Moniz got most of the attention. But the real stars were hundreds of new technologies on display with the potential to dramatically enhance the grid’s efficiency, reliability and affordability. Energy utilities will be the ultimate beneficiaries of these advances. Still able to access low-cost capital and armed with regulators’ support, dozens of electric companies have stepped up investment in transmission and distribution systems, as well as renewable energy and storage solutions. These investments boost utilities’ rate base and, by extension, earnings and dividends. Utilities’ biggest growth opportunities come from growing demand for renewable energy and low-cost natural gas—topics that we explored at length in the February issue of Conrad’s Utility Investor. Regulated electric and gas utilities historically have posted annual earnings growth in the low single digits; these trends, coupled with the innovations in energy storage, should enable some of our favorite names to increase their cash flow and dividends at an accelerated rate. All of our Portfolio holdings have reported fourth-quarter results, as have most of the names in our coverage universe. This month’s update to the Utility Report Card has all the details and our latest assessment of more than 200 essential-service companies. We also raised our proprietary Quality Grades on nine stocks and downgraded 11.

Utilities Outperform: Now What?

By Roger S. Conrad on Feb. 7, 2016
Since mid-December 2015, the Dow Jones Utilities Average has rallied more than 12 percent—an impressive performance in what has been a dismal year for US equities. These returns vindicate those of us who resisted the conventional wisdom that rising interest rates spell doom for utility stocks, increasing these companies’ costs of capital and reducing the value of future dividends. But this success brings a new challenge: Many of our favorite utility stocks have rallied above our buy targets. Although these stocks trade at lofty valuations today, weakness in the US economy and deterioration in key technical indicators suggest that equities could suffer further downside in coming months. Keep your powder dry and stay focused. Our favorite utilities boast low costs of debt and equity capital that put them in prime position to accelerate their earnings and dividend growth by investing in renewable energy and gas distribution and transportation. My colleague Elliott Gue has called for utility stocks emerge as the top-performing sector in the S&P 500 this year—I can’t say that I disagree. But investors must remain selective.

New Year, Same Challenges

By Roger S. Conrad on Jan. 11, 2016
For the 39th time since 1969, the Dow Jones Utilities Average rallied in the fourth quarter. But this upside didn’t prevent the benchmark from finishing the year with a 3.1 percent loss, the index’s first negative return after a positive January since 1987. Fortunately, the primary catalyst for the loss—uncertainty about when the Federal Reserve would start raising interest rates—no longer exists. And just like the beginning of the 2004-06 tightening cycle, utility stocks have gained ground despite weakness in the broader market. But last year’s challenges remain in play for 2016. Energy prices have yet to find a bottom. Non-investment grade debt has become crushingly expensive to refinance, tightening capital markets for all but the strongest companies. Emerging markets continue to struggle. And any international currency not pegged to the US dollar find itself under pressure. The Quality Grades for the 214 essential-service companies tracked in our Utility Report Card provide insight into the spectrum of risk and help investors to avoid the riskiest names.

Talking Utility Stocks

By Roger S. Conrad on Dec. 6, 2015
I’m hosting an exclusive online chat for Conrad’s Utility Investor subscribers at 2 p.m. ET Wednesday, Dec. 9. The format is simple: You ask me any questions on your mind; I stay online until all questions are answered. And don’t worry if you can’t stick around for the entirety of this marathon discussion; a transcript of the proceedings will be available the next morning. We’ll discuss macro developments or specific stocks covered in my Utility Report Card—whatever’s on your mind. Given the severe downdraft in oil and gas prices since summer 2014, I expect to receive a lot of questions about our outlook for these commodities and midstream energy names that own pipelines and other infrastructure. The indiscriminate selling of these stocks has propelled yields into the stratosphere, reflecting concerns about volumetric and counterparty risks and questions about these companies’ ability to grow or even sustain their distributions. With the debt and equity markets effectively closed for many energy stocks, funding remaining growth projects will be a challenge. Although master limited partnerships (MLP) and other midstream operators face real challenges, the selloff afflicting these names has engulfed survivors whose growth prospects remain intact. As always, indiscriminate selling creates opportunities for discriminating investors. This month’s feature article highlights my top pick in each of the nine industry groups tracked in my Utility Report Card as well as names that you should avoid at all costs. We also revisit Kinder Morgan (NYSE: KMI) in the light of the company’s recent press release indicating that the firm will reevaluate its dividend policy for next year.  

Four Keys to the Next 12 Months

By Roger S. Conrad on Nov. 7, 2015
With 90 percent of the companies in our Utility Report Card having reported quarterly results, five times as many names increased their earnings guidance than those that revised their outlook lower. Our favorite utilities have continued to deliver the goods and look well-positioned to weather any storms, thanks to their limited operational risk, supportive regulators, low costs of capital and exposure to various growth drivers. Despite solid third-quarter results from most utilities, the Dow Jones Utilities Average has given up 3.6 percent of its value in the fourth quarter—usually a period of seasonal strength. Some of this weakness reflects expectations that the Federal Reserve will raise interest rates, eroding the value of utilities’ dividends. Never mind that the Dow Jones Utilities Average outperformed during the Fed’s last tightening cycle or that normalizing monetary policy will occur gradually. With technical indicators suggesting that US equities could slip into a bear market next year, we’ve taken profits on a few big winners and will stick to our tried-and-true strategy of buying high-quality names when they trade at favorable valuations.  

Staying the Course

By Roger S. Conrad on Oct. 12, 2015
Will utility stocks avoid their first down year following a January gain since 1987? Since early August, the Dow Jones Utilities Average has outperformed the broader market, narrowing its year-to-date loss to the mid-single digits. And this basket of utility stocks has rallied in the fourth quarter on 38 occasions since 1969, including a 13.1 percent gain last year. Although strong business fundamentals and investors’ preference for safety in uncertain times bode well for utility stocks in the fourth quarter, an aging bull market means that investors should remain cautious. This year, we’ve taken advantage of what the market gives us to exit weaker names and high-grade the Portfolio by adding best-in-class utility stocks when they pull back to favorable valuations. Most of these stocks have posted gains since they joined the model portfolio, while the six stocks we sold have slipped even lower. With technical indicators suggesting that the epic bull market of the past six years may be winding down, we continue to highlight the strategy of setting buy limit orders to purchase our favorites at dream prices. (See Dream a Little Dream for more on this strategy.) Four of the stocks on our list have already hit these levels and surged in subsequent trading sessions. Shares of Chevron Corp (NYSE: CVX), for example, have rallied 26 percent since they hit our dream buy price of $70 per share. Narrowing market leadership and other technical indicators suggest that the S&P 500 could suffer a correction of at least 20 percent in the first half of 2016. In light of this elevated risk, investors should continue to focus on the highest-quality names, keep some dry powder to take advantage of buying opportunities and consider using our dream prices strategy. Regardless of whether we’re in a bull or bear market, Conrad’s Utility Investor always strives to steer you toward stocks backed by strong underlying companies—the best way to build sustainable wealth.  

Beyond the Fed

By Roger S. Conrad on Sep. 15, 2015
From June 2004 to June 2006, the US Federal Reserve raised the benchmark interest rate by 425 basis points to 5.25 percent. Over this period, the Dow Jones Utilities Average generated a total return of more than 61 percent. Utility stocks stumbled a bit in the early part of 2004, when speculation swirled that the Fed would raise interest rates. But once the central bank made its move, these stocks recovered swiftly. Bottom Line: During the Fed’s most recent tightening cycle, the Dow Jones Utilities Average posted its second-best two-year return since World War II. Market history is one reason we’re not concerned that rising interest rates will sap our favorite dividend-paying utilities. And the prospect of elevated volatility in the near term creates opportunities, enabling us to add high-quality names to our model Portfolios at favorable entry points. Meanwhile, a combination of attractive valuations, low costs of capital and the never-ending quest for scale has fueled a wave of utility mergers and generated windfall profits for lucky shareholders. This month’s feature article highlights three strategies for investors to profit from the upsurge in mergers and acquisitions in the utility and telecom sectors.  

Strength in Numbers

By Roger S. Conrad on Aug. 11, 2015
The bull market for stocks that began in March 2009 continues to charge ahead, while volatility, as measured by options trading, remains near an all-time low. However, some sectors and equity groups find themselves in a painful bear hug. The prospect of further downside from crude-oil prices has extended the energy sector’s mauling after a brief recovery rally earlier this year. And the Alerian MLP Infrastructure Index, a capitalization-weighted index of 25 traditional master limited partnerships, has given up almost 40 percent of its value over the past 12 months. Up until a few weeks ago, investors couldn’t get enough exposure to renewable energy, especially rapidly growing yieldcos. But these niche securities have sold off precipitously, with the Bloomberg North American Power Yieldco Index tumbling more than 20 percent since the end of May. Meanwhile, a rampant US dollar has eroded the value of American investors’ international equities and their dividends, though this headwind has abated of late. Amid all these challenges, the Dow Jones Utilities Average has perked up after a difficult spring, rallying 8 percent from its low in late June. Some of these inflows could come from money rotating out of dividend-paying energy stocks, a repeat performance of a trend that emerged when oil prices collapsed in fall 2014. Although the Dow Jones Utilities Average remains well off its high in late January, valuations look reasonable and a period of seasonal strength is just around the corner. More important, earnings have lived up to management teams’ guidance from the beginning of the year. Of the companies covered in our Utility Report Card, 20 revised their guidance higher when they reported quarterly results and 141 maintained their outlook.

Focused on the Long Term, Opportunistic in the Near Term

By Roger S. Conrad on Jul. 12, 2015
The bull market’s seventh year is off to a less-than-rousing start for income investors, with the Alerian MLP Index down 11.5 percent and the Dow Jones Utilities Average down 6.5 percent. Even shares of American Water Works (NYSE: AWK), the largest US water utility, have given up 4.7 percent of their value in 2015. Meanwhile, the S&P 500 has gained only 0.7 percent this year. In our coverage universe, the S&P Telecommunication Services Index has emerged as the big winner, eking out a 2.3 percent total return. This weakness in US equities reflects an uncertain macroeconomic environment that’s clouded by China’s slowing growth and the Greek sovereign-debt crisis. A muddy outlook for US economic growth hasn’t helped matters. Speculation about when and to what extent the Federal Reserve will raise interest rates has heightened volatility in the stock market. Meanwhile, oil prices appear poised for another downdraft, now that we’ve passed the peak of the summer driving season. Over the past six years, best-in-class utility stocks have followed market corrections with big-time gains. We expect more of the same once the market settles down, especially if our favorites post solid second-quarter results. Nevertheless, investors have ample cause for caution. The Dow Jones Utilities Average’s performance this year bears an eerie resemblance to 1987, the last time the sector faltered badly after a winning January. And another breakdown in oil prices, an interest rate hike and/or more weakness in China could roil equity markets further. My midyear strategy balances a long-term focus on quality and value with short-term opportunism: By cashing out of outperformers with limited upside, we can stockpile some dry powder to deploy in a correction. We’ve sold about half a dozen Portfolio holdings since mid-2014, booking sizable gains on most. This month, we’re liquidating our position in Conservative Income Portfolio holding ONE Gas (NYSE: OGS) for a 38.1 percent profit. Although the gas utility boasts a solid dividend, the stock trades at 21 times earnings—a lofty valuation that doesn’t reflect emerging questions about future growth.

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ABOUT ROGER CONRAD

Roger S. Conrad needs no introduction to individual and professional investors, many of whom have profited from his decades of experience uncovering the best dividend-paying stocks for accumulating sustainable wealth. Roger b