With the Fed announcing that it wasn’t planning on ending its quantitative easing programs just yet, investors have once again plowed head first into anything with yield. That means utility stocks are once again back on the menu for many retirees and those looking for a little safe dividend income.
After all, the sector is responsible for delivering essential services and even in times of duress, people need to heat/cool their homes and keep the water and electricity flowing. That fact has made utility companies a steady source of dividend income for decades. So it’s no wonder why they have been given the nod by many investors in the low rate environment.
Yet, not all utilities are created equally.
Sure, the bulk of their operations still are about producing power. However, over the last ten years or so, more and more utilities have moved into some other areas in order to generate returns. That’s included some very non-essential and varied services.
For investors, taking a look under the hood is key when buying into a utility.
Regulated Vs. Non-Regulated
When we tend to think about a utility company, power or water plants come to mind. And given that these facilities provide vital and fundamental needs for society, they often come with a heap of government regulation.
That regulation can come from environmental standards, but more commonly comes down to just how much that utility can charge per unit of water, natural gas or electricity to its customers. These regulated operations form the backbone of the industry and really make up the bulk of the sectors earnings — and therefore juicy dividends.
But sometimes this just isn’t enough.
To produce higher returns than what can be achieved via regulated power plants, some utilities have taken the plunge and have added non-related assets. This actually includes sectors like banking, retail operations and real estate development. These side businesses can be tucked within the company’s non-regulated assets. While they can provide a nice “boost” to profits — as they are outside the cold hand of regulators — they can be a huge drag if they don’t perform.
Utility stalwart Wisconsin Energy (WEC) slashed its dividend nearly in half in 2000 on that back-heavy capital investment resulting from some non-regulated assets. That cut took investors by surprise. Since then WEC has recovered, but it just goes to show that these other assets can hurt. They can also destroy, if investors aren’t careful.
Everybody’s favorite fraud ENRON technically was considered a utility. However, its generating and pipeline assets weren’t what got the firm into trouble. It was hidden losses from a side business — energy trading — that eventually did the firm in.
The lesson in all of this is to know what you own.
Some Utilities That Aren’t
Paying a 5% dividend, Hawaiian Electric Industries (HE) is the state’s largest utility, providing electricity through renewable energy sources and fuel oil to more than 95% of the islands. That’s all well and good, until you consider that HE also operates in another, completely different sector.