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Income Investing

Two to Buy

By Roger S. Conrad on Jun. 30, 2015

The Dow Jones Utilities Average has given up almost 13 percent of its value from the all-time high hit in late January 2015, reflecting profit-taking after last year’s rally and concerns that rising interest rates will bring further downside to the sector and other dividend-paying stocks.

These headwinds put the Dow Jones Utilities Average in danger of posting its first annual loss after a positive January since 1987, a year whose trading action bears a striking resemblance to what’s transpired thus far in 2015.

(Click graph to enlarge.)UTIL 1987 vs 2015

Although the annual returns posted by the Dow Jones Utilities Average and baskets of other dividend-paying stocks exhibit scant correlation to movements in interest rates, the knee-jerk selloff that occurs when interest rates tick up can present a near-term headwind.

After a short-lived recovery rally in the spring, gloom has enveloped the energy sector once again. Although crude-oil prices appear to have stabilized for the time being, the prices of natural gas liquids (NGL)—ethane, propane, butane and natural gasoline—have continued to fall because of production gains and an oversupplied domestic market.

Producers and midstream companies with direct exposure to NGL prices—primarily those engaged in gas processing—will feel the pain in the second quarter.

We also wouldn’t be surprised if crude-oil prices were to come under pressure when the summer driving season winds down and downstream operators close some of their refining capacity for maintenance.

Overall, we continue to expect and prepare for a multiyear period of subdued oil and gas prices. Companies in the energy sector continue to adjust their capital allocations to this new reality.

In short, now is not the time for investors to throw caution to the wind, even in energy and utilities, two sectors that have generated solid returns during the current bull market.

However, two stocks that I cover in Conrad’s Utility Investor look like good buys in the current environment. Subscribe today for instant access to my proprietary quality grades and assessment of more than 200 essential-services stocks.

AmeriGas Partners LP’s (NYSE: APU) stock has pulled back with the rest of the Alerian MLP Index, reflecting concerns about rising interest rates and questions about the group’s ability to live up to the market’s expectations for growth.

But the nation’s leading propane distributor continues to deliver solid results, regardless of whether propane prices surge, as they did during the 2013-14 polar vortex, or plummet, as they have over the past 12 months.

AmeriGas Partners’ pushes through changes in propane prices to its customer base; these fluctuations affect revenue but don’t impact the master limited partnership’s (MLP) operating cash flow or distribution coverage.

However, the severe downdraft in propane prices in 2015 should help to stimulate demand this winter; assuming that the weather cooperates, the MLP should enjoy an uptick in sales volumes.

A highly fragmented market also affords AmeriGas Partners ample opportunity to pursue bolt-on acquisitions that add cash flow and further improve the firm’s industry-leading economies of scale.

And now that AmeriGas Partners has digested the acquisition of Heritage Propane from Energy Transfer Partners LP (NYSE: ETP), the firm has the capacity to consider another transformative deal.

With an 8.1 percent yield and reliable annual distribution growth of almost 5 percent, AmeriGas Partners LP looks like a good bet for conservative investors who can stomach some near-term volatility.

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A recent article in the Wall Street Journal attributes the pullback in the Dow Jones Utilities Average to the prospect of higher interest rates and posits that these equities have a theoretical duration of 23 years, which translates into greater sensitivity to interest rates.

These sensationalist claims don’t hold water when you examine historical market data; the Dow Jones Utilities Average exhibits more of a correlation to the S&P 500 than to the yield on 10-year Treasury notes.

Nevertheless, speculation about when the Federal Reserve will raise interest rates continues to exert an enormous influence on investor psychology and utility stocks’ near-term price movements.

Earlier this year, we came close to cashing out of Wisconsin Energy Corp (NYSE: WEC), which rallied to almost $60 per share earlier this year on enthusiasm for the company’s pending acquisition of Integrys Energy Group (NYSE: TEG).

With the deal nearing completion, the stock has dropped into the mid-$40s, likely because of investors’ concerns about rising interest rates. At these levels, the stock looks like a good buy.

The proposed transaction survived intense regulatory scrutiny in Wisconsin, Michigan, Minnesota and Illinois without the addition of concessions that would jeopardize the deal’s economics.

Wisconsin Energy’s guidance calls for a payout hike of 8 percent when the deal closes and annual dividend growth of about 7 percent thereafter—an acceleration from the run rate contemplated prior to th acquisition’s announcement. Investments in the company’s regulated utility operations will drive much of this upside.

Salutary relations with regulators and a solid balance sheet make Wisconsin Energy Corp an excellent buy for investors with a longer time horizon, though worries about the Federal Reserve’s monetary policy could lead to additional downside in the near term.

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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