Scana (SCG) a Top Utility Stock to Buy

The South Carolina company is a bedrock investment


I’ve talked a lot over the past spring and summer about my earnings and valuation models’ affection for utilities. And it is showing no let-up in that bias here in mid-August, continuing to point toward U.S. and overseas utilities that pay annual dividends yielding over 4.5%. My latest utility stock to buy is Scana Corp. (NYSE: SCG).

Scana Corp. is a South Carolina utility that is up nicely in this squirelly summer. Investors cannot resist the attraction of stable, high-dividend utilities this summer, and this one pays a 4.6% annual yield.

I don’t know about you, but I do love learning about utilities. I don’t see them as boring due to the fact that they are heavily regulated. I see them as the providers of one of the most fundamental parts of our lives. They are the bedrock of modern existence, and yet they are totally taken for granted. If you really think about what separates modern life from the Middle Ages, it is cheap and prevalent power.

Scana’s major subsidiary, South Carolina Gas and Electric, provides electricity to 660,000 customers in offices and homes. I hope they appreciate it. The utility also owns and operates a natural gas business that serves 1.2 million customers in North Carolina, South Carolina and Georgia.

SCG is one of the smaller American utilities with a $4.95 billion market cap and $4.38 billion in annual sales. The company has big plans to expand. In 2008, SCG proposed the construction of a new nuclear plant in South Carolina. The $6.3 billion price tag of its 55% stake would double the size of the company over the decade.

The utility currently generates 22% of its power from hydro and nuclear sources. Construction of a nuclear plant would bring that total to 58% and further limit SCG’s exposure to fluctuating commodity prices and environmental criticism.

Scana shares have steadily outperformed other utilities and the S&P 500 since 2001, as shown above: +80%, vs +13% for the average utility and -15% for the market. Expect the relative strength to continue as investors seek dividend investments as an alternative to bonds. The firm has historically achieved some of the highest returns on equity of any utility, at 10.25%, because of favorable treatment from regulators. Consistent cash flow has allowed the utility to raise its dividend 30% since 2005.

Electrical demand has been strong in its service area despite the weak economy and South Carolina’s 10.7% unemployment rate, which is 1.2 percentage points above the national average. Total retail usage increased 7.3% and industrial usage jumped 14.8% in the second quarter relative to the same period last year.

Scana’s smaller natural gas business is also showing signs of improvement. South Carolinian regulators granted a $9.1 million rate increase in 2009 while North Carolinian officials recently granted a rate adjustment that boosted return on equity back to historical levels.

Regulatory risk is an inherent issue for all utilities. Scana is one of three finalists seeking a Department of Energy loan guarantee for its nuclear plant. Morningstar analyst Travis Miller argues that the company has benefited from close relationships with South Carolinian regulators in the past and will likely continue the project without DOE backing. A continued economic slowdown could also impair Scana’s ability to raise rates.

Analysts expect Scana to earn $3.22 in 2011 which prices the stock at 12.3x forward earnings. My model suggests earnings of $3.28. Coupled with a historical P/E of 14, we are looking at a $46 price target or 16% upside. SCG also pays a 4.5% dividend. It’s a buy.

As of this writing, Jon Markman was recommending SCG to subscribers of his Strategic Advantage newsletter. For more ideas like this, check out his Trader’s Advantage or Strategic Advantage investment advisory services.

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