Utilities Beginning to Generate Interest for Longs

by: Joe Kunkle October 15, 2008 | about stocks: D / DUK / ED / SO / UPW / XLU    

Joe Kunkle

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Utilities tend to outperform when the economy is in a downturn, and with many of stocks now finding long term support levels and attractive valuation, it looks like a sector that some new money could flow into over the next few months, and is an eye-catching investment.

On, 9/16, we issued a bearish note on the utility sector due to valuation, debt concerns amid a credit crisis, and declining margins. We recommended going long the Ultra-Short Utility ETF (SDP) at $73. The SDP traded to $140 as recent as last Friday and we are now flipping our position and becoming bullish the sector. 

There are multiple factors that have changed our outlook for the sector. First, liquidity is being injected back into the market and the credit concerns are diminishing as the Utility companies should have plenty of Federal and State backing for any debt concerns because our nation needs electricity. Utility companies have not mentioned cutting project spending as of yet, and now it looks unnecessary to do so.

Also, the sector has been one of the most battered and valuation is now at a very reasonable level. Many of the individual stocks have found long term (2 to 5 year) support levels to begin a rally. Although the sector is still trading at higher multiples than many of its peers, we feel the investors looking to get their feet wet, and get back in the market may be inclined to buy Utility stocks, a safe haven investment with one of the lowest Betas historically. People put their trust in utilities because people need electricity, water, gas and phones. Also, the dividend yields of utility stocks are greater than the other sectors, and this will also attract investors.

Lastly, natural gas prices have stabilized and found support so the issue of declining margins and uncertainty in the companies’ financial performance will lessen to a degree. Regulators are lenient with passing on energy costs to consumers, so the energy prices are not as big of a concern as some think.

All of these factors point to Utility stocks outperforming over the next year, and recent positioning in the options market shows that others feel this is true. The Utility ETF (XLU) had one of the lowest put-to-call ratios in the market yesterday with 32,149 calls trading versus only 1240 puts, a bullish indicator. Most of the action was betting on the October $29 calls in the ETF, and the volume was extremely high. 

Please see the chart below for the technical indicators on the XLU (chart courtesy of Prophet Charts, ThinkorSwim):

Our favorite plays in the Utility sector are Consolidated Edison (ED), Dominion Resources (D), Duke Energy (DUK), and Southern Corp (SO).

Disclosure: The author has no position in any of the above equities or ETFs.

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This article has 7 comments:

  •  
    Oct 15 02:30 PM
    But what does this mean for solar power?
    Reply | Link to Comment
  •  
    Oct 15 05:43 PM
    Worth a beginning look perhaps... but be careful. There was definitely massive over-valuation in the utility sector over the last few years. Look at how utilities performed before that, and they can often be analzed as an interest-rate vehicle. What type of dividends do they pay in relation to bond classes? While its true the garden-variety recession might result in this sector being a reasonable place to park, what we have coming could be dramatically different. Both in the level of reduced consumption and in sharply increased long-term bond rates due to the most MASSIVE injections of government currency ever. Take a look at how another sector which is seemingly another good place to look is getting slammed, muni-bonds. The market seems to be starting to incorporate much heightened long term rate concerns. There have been many times when a rise in long-term yields results in utilities yields (dividends) going up in tandem as their prices going down. Yes, keep your eyes on this... nibble perhaps.... but be VERY careful.
    Reply | Link to Comment
  •  
    Oct 17 12:48 AM
    Nibble? Be careful? The Dow is sitting near a ten year low! This isn't the time to put a pinky toe in. This is the time to grab shares like a crazy person! There is PANIC in the markets! There has been a MASSIVE sell off! Now is the time to buy and wait. Maybe you could catch another 10 to 20% drop...or miss the bottom. This is the opportunity of a lifetime and you are recommending people to be CAREFUL!

    That is INSANE!

    I am so nervous about still having a little cash in my account. I am greedy! I want the market to drop some more so I can invest some more. God help anyone who gets between me and my computer if the market drops another 10% below Dow 8000! If you haven't been backing up the truck these last two weeks, you need to find a new hobby! This is what it's all about. Buy when the market is low and people are PANICKING!

    I hope you didn't miss the bottom. I hope you recognize it when it really gets here. Maybe it will wait patiently for you to make a rational decision and then you can tread confidently into its open arms. I just buy when it is really low.

    Nibble! Incredible. Then what...take a big bite when the market is up?
    Reply | Link to Comment
  •  
    Oct 17 10:49 AM
    better to nibble and have cash to nibble again than to invest everything into the wrong sector or individual stock which may implode.
    Reply | Link to Comment
  •  
    Oct 17 10:55 AM
    CPN, out of Bankruptcy so legacy costs are not a problem, expanding its Geothermal business in Northern California. Purely non-carbon electricity with future Carbon Tax Credits to generate additional cash flow. Last I saw was that Geo generation was about 30% of total, a couple of months ago.

    I'm not in it, yet. Won't be until the forced selling is over or oil prices stabilize.
    Reply | Link to Comment
  •  
    Oct 17 12:47 PM
    lower feedstock prices on the front end and a fresh rate increase on the back end with a steady stream of folks who can't live without it. I bought back 33% of my ED position at $35 on crash day, that I sold last month. Here's a kicker, go around your house and count the things that you plug in, then think about the amount of things you had that you plugged in ten years ago, then think about the population growth, this is secular growth at its finest. Just look at all the crap you have for your tv now, and nothing is ever "off" anymore now it "sleeps" .
    Reply | Link to Comment
  •  
    Oct 20 10:55 AM
    Utilities continue to be upper tier opportunities. Consolidation has been the key coupled with slow moving metrics. Most are big giants whose performance and long term planning play out slowly over many years. This facilitates analysis enhanced by excellent transparency.

    I have been in this space for over 25 years and continue to believe it should be an important sector. Yields and surprisingly good growth is hard to beat. Power is a life blood. While some households and industries may of necessity cut back power consumption, cash flow will continue to be favorable.

    I'm a buyer here.
    Reply | Link to Comment
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