Looking for Retirement Income? Stay Away From Utes Right Now

by Marc Bastow | May 30, 2013 7:00 am

Looking for Retirement Income? Stay Away From Utes Right Now

Back in February, I expressed concern[1] about energy giant Exelon (EXC[2]), which simultaneously announced a 38% decline in fourth-quarter earnings and a 41% cut in its dividend. Retirement investors might love utilities’ yields, but EXC was squarely off the shopping list.

Fast forward to today, and Exelon is on the wrong side of the news again — this time, an analyst downgrade from Deutsche Bank sending EXC shares down nearly 10% in two days. DB’s concerns are focused on Exelon’s ability to generate revenue growth over the 2015-17 time horizon.

While EXC actually put together a decent rally following its dividend cut, its total gains since my February article have been shaved to about 1%, while its annual yield is more than 2 percentage points lower than just before it announced the dividend cut.

My opinion on Exelon is no different now: Stay away.

But what about the rest of the group? Is it time to re-evaluate the sector for those seeking safety in what’s always been considered a “defensive” sector?

Yeah.

To start, Daniel Putnam points out[3] that the Utilities SPDR (XLU[4]) is behaving rather poorly compared to the SPDR S&P 500 ETF (SPY[5]) — the XLU is underperforming the SPY in good times, and also losing ground to the index on dips. Not a particularly strong sign for long-term investors who threat these stocks as a “bond proxy,” and perhaps a cautionary note for investment in the ETF and sector as a whole.

Side-by-side, the XLU-SPY comparison is pretty depressing. XLU yields 3.9%, sure, but has only appreciated 8% year-to-date. Meanwhile, the SPY has not only doubled those returns, but also offers 1.9% in dividends to boot.

Worse yet, utilities are looking awfully expensive. Back in February, Jeff Reeves pointed out that the Dow’s utility index was “hot” at a trailing 12-month P/E of 22.2; today, that number is 25.9, according to WSJ Market Data[6], up from just under 17 a year ago.

This spells “danger” to me. At the very least, it’s a good case to keep new money away from the sector.

Sure, if you’re looking for big dividends from the individual names, you’ll find them — stocks like Duke (DUK[7], 4.5% yield), Southern (SO[8], 4.5%) Consolidated Edison (ED[9], 4.2%) and Dominion (D[10], 3.9%) all offer great headline yields. But as you’d infer from the sector’s average dividend, you’ll be paying a premium for all of these. Not to mention, each has their own issues outside of price.

Duke, for instance, operates seven separate nuclear facilities, and the cost of keeping them up-to-date and active is enormous. As energy prices continue to fall — and the popularity (and subsidizing) of alternative sources like solar and wind rise — those costs could squeeze these giants’ margins.

Meanwhile, Dominion operates in both the coal and nuclear arena, both fraught with danger. Motley Fool’s Maxxwell A.R. Chatsko provides some evidence[11] that’s already happening at Dominion and Exelon, and could affect a wider swath of nuclear- and coal-based utilities.

As for ConEd, perhaps they’ve already seen some of the writing on the wall; the company just inked a deal[12] with California-based Sempra Energy (SRE[13]) to partner in two of Sempra’s solar facilities, taking a 50% stake in each.

I consider Southern to be the best play of these four (full disclosure: I own SO shares), if for no other reason than its virtual monopoly on the growing Sun Belt region, including Georgia, Alabama and Mississippi.

While I don’t think investors jump into these stocks for growth, they at least should be concerned about stagnant revenues and squeezed margins, or events like regulatory measures favoring alternative power initiatives, wicking away what little gains they do provide.

If you bought into the sector several years ago (like I did with SO), you’re still looking not only at nice gains, but a great yield on cost, so there’s no pressure to pull the trigger. But if you’re not in utilities, and looking for the “safety” aspect historically associated with them, I suggest you wait for the more quality names to come even closer to earth.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he was long SO.

Endnotes:
  1. I expressed concern: http://investorplace.com/2013/02/exelon-dividend-cut-exc-mco/
  2. EXC: http://studio-5.financialcontent.com/investplace/quote?Symbol=EXC
  3. points out: http://investorplace.com/2013/05/dont-expect-utilities-to-stay-defensive-during-a-downturn/
  4. XLU: http://studio-5.financialcontent.com/investplace/quote?Symbol=XLU
  5. SPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPY
  6. WSJ Market Data: http://online.wsj.com/mdc/public/page/2_3021-peyield.html
  7. DUK: http://studio-5.financialcontent.com/investplace/quote?Symbol=DUK
  8. SO: http://studio-5.financialcontent.com/investplace/quote?Symbol=SO
  9. ED: http://studio-5.financialcontent.com/investplace/quote?Symbol=ED
  10. D: http://studio-5.financialcontent.com/investplace/quote?Symbol=D
  11. provides some evidence: http://www.fool.com/investing/general/2013/03/30/can-america-blow-away-nuclear-power.aspx
  12. just inked a deal: http://www.yourindustrynews.com/sempra+u.s.+gas+%26+power,+consolidated+edison+development+announce+solar+partnership_90634.html
  13. SRE: http://studio-5.financialcontent.com/investplace/quote?Symbol=SRE

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