This has been the summer of the utility stocks, so let me now shed some light on one of my model’s favorites at this time: Connecticut-based utility UIL Holdings (NYSE: UIL). Its major subsidiary, the United Illuminating Co., which I would nominate as one of the best names ever for a utility, serves 325,000 customers in the Greater New Haven and Bridgeport areas. UIL also pays a fat 6.4% annual dividend.
The Connecticut energy provider is one of the smallest and cheapest utilities that we have ever owned. Its $888 million in annual sales exceed its tiny $800 million market cap, giving it a price to sales ratio under 1. Utilities generally trade at a slight premium to this ratio. For comparison, Southern belles Cleco (NYSE: CNL) and Scana (NYSE: SCG) trade at 1.7x and 1.1x sales, respectively.
We have looked at a lot of utilities over the past three months but it is hard to overstate their importance. They power daily essentials like computers, laundry machines, dishwashers, televisions, and lights, and economic drivers such as production lines, networks, and servers. People expect uninterrupted power 24 hours a day, 365 days a year.
Have you ever stopped to think about how amazing that is? Utilities generate electricity at a central plant and then distribute it hundreds of miles to every single home and business in their operating area. Without them, we would still be in the dark ages.
The stability of utilities and their high dividends has attracted investors seeking to avoid market turmoil. UIL is up +23% (excluding dividends) since 2006 while the S&P has lost -15% of its value. The Connecticut company’s 6.4% dividend also dwarfs the 2.6% yield on 10-year treasuries and will continue to add value to your portfolio even at the common stock remains at $26.
Regulators grant a UIL monopoly in western Connecticut and allow the company UIL to earn an 8.25% return on equity on current projects. This return is slightly lower other utilities but is sufficient to cover capital investments and its hefty dividend. Future projects may achieve returns up to 9.75%. UIL scheduled to open two next generation power units in 2011. The project is receiving significant state subsidies and will help meet Connecticut’s growing power needs.
In late May, UIL purchased three natural gas distributors for $1.3 billion from Iberdrola, a Spanish energy conglomerate. This acquisition will double UIL’s customer base and provides diversification from its electricity generation segment. Chief exec James Torgerso noted that the transaction “immediately transforms UIL while adding organic growth opportunities.”
Torgerson has management level experience with several natural gas and energy transmission companies. He and the rest of this management team own 5.6% of outstanding shares which should be sufficient to align their interests with shareholders. The small utility has roughly $90 million in debt maturing in 2010 that will be easily covered by $184 million in operating cash flow. Moody’s & S&P both rate the utility corporate debt investment grade.
Analysts expect UIL to earn $2.14 in 2011, pricing the stock at 12.2x earnings. Historically, the stock has been valued at a 14x earnings. My model predicts that UIL has a shot at reaching $30 in the next year, which would be 15% higher. Add that to the 6.4% annual dividend, and you’re in business. It’s a buy.
For more ideas like this, please check out Jon Markman’s daily trading advisory service Trader’s Advantage, or his long-term investment letter, Strategic Advantage.
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