Let the solar freaks crow all they want. Neither fossil fuels nor standard electricity are going anywhere. There’s a reason solar and wind combined produce a small fraction of the nation’s electricity, and that’s because they don’t work terribly well.
Some people think investing in utility stocks is a mistake because they are too sensitive to interest rates. Most utility stocks have a lot of debt they use to create and maintain their networks, and the fear is that rising rates on that debt will harm the company’s cash flow.
That would be true if it weren’t for the fact that utility rates are regulated and utility stocks have lobbyists, too. So baked into interest-rate hikes are electric and gas rate hikes.
Sure, utility stocks can have expensive “one-time” charges like damage from weather or the occasional chemical clean-up. But ultimately, the best ones generates reliable cash flow and have a good dividend yield, and that’s why we like them.
Utility Stocks: National Grid (NGG)
I’m partial to National Grid (NGG), an electric and gas utility stock that handles both residential and commercial customers in both the U.K. and New England, so you get geographical diversification. It also has transmission interconnectors between the U.S. and Canada, as well as between France and the Netherlands.
NGG really is a mammoth operation, with 7,200 kilometers of overhead transmission lines, 1,400 kilometers of underground cable and 335 substations. The power generation also includes solar. It’s one of the largest utility stocks you’ll find with a $54 billion market cap.
The utility stock carries a heavy debt load of some $39 billion, but the interest rate is below 5% on average, and there is some $8 billion of cash on hand. For anyone who says that utility stocks are not growth vehicles, please note that FY11 showed net income of $3 billion, FY12 had $3.27 billion, and FY13 hit $4.1 billion.
And for those who invest in utility stocks for the dividends (which is most of us), NGG pays a generous 5% dividend yield.
Utility Stocks: ITC Holdings (ITC)
ITC Holdings (ITC) is a nice way to diversify utility holdings. While it does own and operate 15,000 miles of its own high-voltage transmission operations in the Midwest and upper Midwest, ITC also operates as a conduit. It transmits power from one distribution system in a locality to another. Think of it as a rental rail line.
ITC Holdings is a smaller company with a $5.7 billion market cap. It’s not cash- or dividend-heavy, with $9 million of cash on the books and 1.7% dividend yield. Meanwhile, ITC holds $3.75 billion in debt but the debt service is also under 5% on average.
However, ITC is a growing operation, with net income increasing from $171.6 million in FY11, to $187.9 million in FY12, to $233.5 million in FY13. It already has $124 million through the first half of this year.
Utility Stocks: Entergy (ENR)
Entergy (ETR) is another way to diversify your utility holdings. It generates power from several sources: fossil fuel, nuclear, coal and hydro. It also isn’t just a utility company, but also sells nuclear energy wholesale in the northern U.S.
The utility side operates in the southeast and southern U.S., in Arkansas, Mississippi, Texas and Louisiana. And Entergy services 2.8 million customers, including residential, commercial, industrial, and government.
The balance sheet shows $650 million in cash offset by $12 billion in debt, also being serviced at around 5% on average. Some non-recurring charges have hit net income the past two years, but the company is back on track, generating $590 million in the first half of the year.
This utility stock’s cash flow remains relatively consistent, so the 4.2% yield feels pretty safe.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets at @ichabodscranium.