Overtaken by Current Events

Widows and orphans, pay attention: Electric utility stocks aren’t what they used to be.

Long valued for their steady, government-regulated rates of return and high dividend yields, the once-sleepy electric industry is now in a state of utter turmoil as deregulation of power suppliers sweeps the nation.

“It’s a pretty confusing time right now,” said Rick Eckenrodt, co-manager of the Lindner Utility Fund in St. Louis.

California and at least a dozen other states are moving to eliminate decades-old monopolies and introduce competition into electric energy. Earlier this month, California’s Public Utilities Commission voted to allow an unrestricted market in the state--where customers spend $20 billion annually for electricity--by year’s end, in an effort to reduce the state’s notoriously high electric prices.

That’s good for consumers. But many utility investors have raced to the sidelines until the dust settles.

“My major concern is that there’s a major lack of predictability for both earnings and dividends” of utilities, said analyst Raymond Moore of Dillon, Read & Co. in New York, who does not have a single “buy” recommendation on any utility right now.

“I don’t know what kind of growth rates to put on these companies,” he said.

It’s that attitude that has left many utility stocks lagging well behind the broader stock market for more than a year. While the Standard & Poor’s 500 index has surged 24% over the last 12 months, S&P;’s index of 26 electric utility stocks has dropped 3%. Higher market interest rates, which make bonds more competitive with high-dividend stocks, also have hurt utilities.

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Among California’s three major providers of electricity, shares of PG&E; Corp. (ticker symbol: PCG), the San Francisco-based parent of Pacific Gas & Electric, have risen only 2% over the last year, to $23.50 as of Monday. Enova Corp. (ENA)--the holding company for San Diego Gas & Electric, and which is planning to merge with Pacific Enterprises (PET), the owner of Southern California Gas Co.--has gained 8% over the last year, to $23.25 now.

In contrast, Edison International (EIX), the Rosemead-based parent of Southern California Edison, has been a standout: Its shares have jumped 42% over the last year, to $22.75 currently.

But overall, Edison’s recent performance has been the exception rather than the rule. “I’m a value investor, which means I like buying stocks that are cheap and hated, and that seems to apply to the whole utility industry,” quipped Sheldon Simon, manager of the $1.2-billion Putnam Utilities Growth & Income Fund. “This sector has been out of favor since the middle of 1993.”

Nor is the situation expected to improve much soon, in part because more and more utilities are expected to slash their dividends to have the cash needed to compete in a deregulated market.

Many already have taken that step, such as Ipalco Enterprises Inc. (IPL), the parent of Indianapolis Power & Light, which shocked the industry by cutting its quarterly payout by 32% in April.

In other words, it’s getting hard to justify buying a utility stock simply as a dividend play.

“The average electric utility [yield] is 6% and change, but you could get a [30-year U.S.] government bond for close to 7%, and with the government, I know I’m going to get my money back,” Moore said.

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Even if utilities have extra cash on hand after cutting their dividends, earnings growth in a more competitive market won’t be easy to achieve, analysts said.

With deregulation, “electricity is going to be a commodity sold on price, [and] the company that has the lowest costs for their electricity is going to have the flexibility to do what they need to do to win customers,” said David Thickens, analyst at brokerage Dain Bosworth Inc. in Minneapolis.

That’s why he likes Public Service Co. of Colorado (PSR): The firm is “one of the low-cost producers in the industry” and thus is “well-prepared to face the rapidly changing utility environment,” he said. The stock, now at $40 a share, is up 18% over the last year.

Barry Abramson, utility analyst at Prudential Securities Inc. in New York, has buy recommendations on several stocks--although none in California--that he believes are competitive companies with projected growth rates in earnings and dividends that will top the industry’s averages.

Among Abramson’s picks: CMS Energy Corp. (CMS), based in Dearborn, Mich.; Duke Power Co. (DUK), which provides power in the Carolinas; and Texas Utilities Co. (TXU), based in Dallas.

As for the California companies, Putnam’s Simon said each one is embarking on a different strategy with the advent of deregulation.

“Enova happens to be one of my largest holdings,” he said, “because they’re on a strategy where they will be the most plain-vanilla company in the state,” and that will be an asset amid the confusion of deregulation, he believes.

With its merger with Pacific Enterprises, now pending, Enova plans to stick with the business of providing electricity and gas to its home state. “If you want to select a utility where you can look at them today and have a sense of what they’ll be in the future, this is the company,” Simon said.

Edison International, meanwhile, is looking overseas for growth, and that diversification away from the tumult of the California market is a key reason why the company’s stock has risen sharply over the last year, Simon said. That trend will continue, as Edison’s sales growth “won’t be fueled much by growth in California” in the next year or so, he said.

But Edison stock’s jump in price makes it too costly to purchase now, said analyst William Tilles of Smith Barney Inc., who last week downgraded Edison to “neutral” from a “buy” on that basis alone.

As for PG&E;, the company “is in the process of deciding where they want to go” in a deregulated world, even though it recently agreed to buy Valero Energy Corp.’s (VLO) natural gas business, Simon said.

“In a way, PG&E; has the greatest opportunity and the greatest challenge, because it’s starting more with a blank page than Edison and Enova,” Simon said. But the stock market is discounting PG&E;’s stock until the company’s strategy is clearer, he added.

Lindner’s Eckenrodt has Nipsco Industries Inc. (NI) in his portfolio. He likes the Northern Indiana utility’s 4.4% yield, its solid internal growth and its record for making good investments in outside energy projects and firms.

Eckenrodt has also made a speculative bet: El Paso Electric Co. (EE), at $6.69 a share currently. “It was a buyout candidate, then it went into bankruptcy and now it’s doing a great job of paying back its debt,” he said. “I’m sure it will come into play again” as a takeover candidate.

Moore also has a speculative favorite: Northeast Utilities (NU). Its stock has plunged to $9.50 now from $25 in 1996, mainly because the company shut down its Millstone nuclear power plant in Waterford, Conn., amid growing safety concerns of regulators. But Moore said that if at least one of Millstone’s three reactors can be restored to service within a few months--”and I think that’s going to happen”--then the stock could catch fire. But, like every speculative suggestion, that’s a big if.

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Though still carrying their familiar high dividend yields, electric utility stocks are mostly hurting because of uncertainty surrounding the industry’s deregulation. Some of the major players:

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Ticker Monday 12-month Dividend Company symbol price % change yield CMS Energy CMS $33.75 +15% 3.2% Duke Power DUK 44.88 -8 4.7 Edison Intl. EIX 22.75 +42 4.4 Enova ENA 23.25 +8 6.8 Nipsco Industries NI 40.63 +9 4.4 PG&E; PCG 23.50 +2 5.1 Public Service Co. of Colo. PSR 40.00 +18 5.3 Texas Utilities TXU 34.50 -13 5.8 S&P; electric utilities index -3 6.2 S&P; 500 +24 1.9

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Note: Stock price and index changes are price only.

Source: Bloomberg News