Tag Archives: utilities

Utilities ETF: XLU No. 1 Select Sector SPDR In 2014

Summary The Utilities exchange-traded fund finished first by return among the nine Select Sector SPDRs in 2014. As it did so, the ETF posted the best annual percentage gain in its 16-year history. However, seasonality analysis indicates it could be facing a tough first quarter. The Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) in 2014 ranked No. 1 by return among the Select Sector SPDRs that break the S&P 500 into nine chunks. On an adjusted closing daily share price basis, XLU rocketed to $47.22 from $36.68, a zooming of $10.54, or 28.74 percent. Accordingly, the ETF outdistanced its parent proxy SPDR S&P 500 ETF (NYSEARCA: SPY ) by an extraordinary 15.27 percentage points. (XLU closed at $47.35 Wednesday.) XLU also ranked No. 1 among the sector SPDRs in the fourth quarter, as it outpaced SPY by 8.28 percentage points. In addition, XLU ranked No. 1 among the sector SPDRs in December, as it outran SPY by 3.83 percentage points. Overall, XLU posted the best annual percentage return in its 16-year history: Its previous record was set in 2003, when it swelled 26.46 percent. XLU appears key to analysis of market sentiment based on the comparative behaviors of the Select Sector SPDRs . If XLU ranks near No. 1 by return during a given period, then I believe market participants are in risk-off mode; if XLU ranks near No. 9 by return over a given period, then I think market participants are in risk-on mode. Figure 1: XLU Monthly Change, 2014 Vs. 1999-2013 Mean (click to enlarge) Source: This J.J.’s Risky Business chart is based on analyses of adjusted closing monthly share prices at Yahoo Finance . XLU behaved a lot better in 2014 than it did during its initial 15 full years of existence based on the monthly means calculated by employing data associated with that historical time frame (Figure 1). The same data set shows the average year’s weakest quarter was the first, with a relatively small negative return, and its strongest quarter was the second, with an absolutely large positive return. The ETF’s October 8.03 percent gain was its sixth-highest monthly return ever. Figure 2: XLU Monthly Change, 2014 Versus 1999-2013 Median (click to enlarge) Source: This J.J.’s Risky Business chart is based on analyses of adjusted closing monthly share prices at Yahoo Finance. XLU also performed a lot better in 2014 than it did during its initial 15 full years of existence based on the monthly medians calculated by using data associated with that historical time frame (Figure 2). The same data set shows the average year’s weakest quarter was the first, with a relatively small positive return, and its strongest quarter was the second, with an absolutely large positive return. Clearly, this means there is no historical statistical tendency for the ETF to explode in Q1. Figure 3: XLU’s Top 10 Holdings and P/E-G Ratios, Jan. 7 (click to enlarge) Note: The XLU holding-weight-by-percentage scale is on the left (green), and the company price/earnings-to-growth ratio scale is on the right (red). Source: This J.J.’s Risky Business chart is based on data at the XLU microsite and Yahoo Finance (both current as of Jan. 7). In the wake of the sea change in bias at the U.S. Federal Reserve , away from loosening and toward tightening, XLU’s record-setting performance in 2014 kind of makes sense, at least in an equity market where share prices are primarily driven by the ebb and flow of asset purchases made by the central bank under one or another of its so-called quantitative-easing programs. It is worth mentioning in this context that the Fed announced the conclusion of purchases under its latest QE program Oct. 29 and that the ends of purchases under its previous two formal QE programs are associated with both a correction and a bear market in large-capitalization stocks, as evidenced by SPY’s dipping -17.19 percent in 2010 and dropping -21.69 percent in 2011. It is also worth mentioning that XLU’s big-time performance last year means that I, as a growth-and-value guy, see neither growth nor value in most of the utilities sector, as indicated by the above chart (Figure 3) and numbers released by S&P Senior Index Analyst Howard Silverblatt Dec. 31. At that time, Silverblatt pegged the P/E-G ratio of the S&P 500 utilities sector as 3.43. In the current environment, I therefore would be completely unsurprised should XLU continue to behave well in the current quarter, not on an absolute basis but on a relative basis (i.e., in comparison with the other Select Sector SPDRs and with SPY). On balance, the ETF may not produce gains, but it might produce losses smaller than those of its siblings. Disclaimer: The opinions expressed herein by the author do not constitute an investment recommendation, and they are unsuitable for employment in the making of investment decisions. The opinions expressed herein address only certain aspects of potential investment in any securities and cannot substitute for comprehensive investment analysis. The opinions expressed herein are based on an incomplete set of information, illustrative in nature, and limited in scope. In addition, the opinions expressed herein reflect the author’s best judgment as of the date of publication, and they are subject to change without notice.

American Electric Power Retains Attractiveness For Dividend Seekers

Summary AEP could sell competitive energy operations if weakness continues to persist in the segment’s performance despite long-term pricing agreements. AEP’s capital expenditures will fuel rate based and bottom-line growth in coming years. Stock’s dividend yield of 3.6% is backed by its cash flows. American Electric Power (NYSE: AEP ) has remained an admired investment option for dividend-seeking investors due to its high dividend yield, which is backed by its cash flows. Also, the company is expected to experience healthy earnings growth in the future, driven by capital expenditure that AEP is making to expand its transmission operations. The company expects to experience regulated rate base growth of 7.5% on average until 2017. Separately, AEP has been considering several options to address challenges faced by its competitive energy operations, including the sale of competitive assets, which will positively affect its bottom-line numbers growth. Earnings growth due to the expansion of regulated energy operations will improve bottom-line growth, and hence strengthen cash flows, which will support dividend growth for AEP in the coming years. Therefore, I believe AEP will deliver a healthy financial performance in 2015, which will positively affect the stock price. Healthy Growth Outlook AEP has made the correct strategic decision to address challenges faced by the company in the competitive energy segment; the company’s competitive energy operations have been adversely affected due to low and volatile forward power prices. AEP is looking for a reliable long-term price agreement to stabilize revenues for the segment. And if the long term pricing agreement does not help AEP address challenges faced by the segment, I believe the company will choose to sell its competitive energy assets. The company recently announced that Goldman Sachs will assist AEP in considering options for its competitive energy operations. AEP’s director of external communication, McHenry said, “We haven’t made a decision about whether or not we’re going to sell them, we’re looking at a variety of options.” Duke Energy (NYSE: DUK ) and PPL Corp. (NYSE: PPL ) are among the leading U.S. utility companies that have sold their competitive energy assets due to the ongoing challenges. Along with its efforts to improve competitive energy operations, AEP has been making capital expenditures to grow it regulated operations, which will improve its top and bottom-line growths in the future. The following table shows the capital expenditures that AEP expects to incur from 2015-2017. 2015 2016 2017 Capital Expenditure ($ -billions) $4.4 billion $3.8 billion $3.9 billion Source: Yahoo Finance Also, the company’s regulated rate base growth is expected to increase at an average rate of 7.5% until 2017, due to the capital expenditures it has been making. The increase in regulated operations will also positively affect the stock price. The following chart shows the rate base growth for AEP from 2013-2017. Source: Company Reports Also, the company has been focusing on reducing its costs. AEP has been working to manage and reduce its operational and maintenance costs, which will help offset the weak results of competitive energy operations and support its long-term bottom-line growth. EPS growth for the company is expected to remain in a range of 4%-6% in the long term, as shown below in the chart. Also, the company is expecting its operating earnings for 2014 to in a range of $3.40-$3.50 per share. Source: Company Reports Healthy Dividends The company has been sharing its success with shareholders through dividends. The company offers a dividend yield of 3.60%, which is backed by its cash flows. Also, the company has consistently increased dividends at an average rate of 4% from 2005-2014. The following chart shows the dividend increases for AEP over the years. Source: Company Reports The following table shows the dividend payout ratio and dividend coverage for AEP from 2012-2014 (Dividend coverage = Operating Cash Flows/Dividends). 2012 2013 2014 Dividend Payout Ratio 60% 60% 55% Dividend Coverage 4.1x 4.5x 4x Source: Calculations and Companies Reports As the company has been making efforts to improve its operations through increasing regulated energy operations, its cash flows will be positively affected, which will help AEP increase its dividends at a healthy pace in the coming years. Due to its safe and healthy dividends, the stock remains a good investment option for dividend-seeking investors. Conclusion As competitive energy operations remain weak, AEP has been taking the correct strategic decisions to improve its performance. There is a possibility that AEP might choose to sell its competitive energy operations, if the weakness continues to persistent in the segment’s performance despite long-term pricing agreements. The capital expenditures that AEP is making will fuel its rate base and bottom-line growth in the coming years. And the stock’s dividend yield of 3.6%, backed by its cash flows, makes it a good investment option for dividend-seeking investors. Due to the aforementioned factors, I am bullish on AEP.

Why Exelon Corporation Will Outperform The Market In 2015

The strong rally in utilities will continue into 2015, despite statements to the contrary from analysts, as the sector is still strongly undervalued relative to the market. Exelon combines an attractive valuation with strong price momentum and EPS growth. We expect the stock to outperform the market by 8.7% over the next 12 months. Entergy Corporation, Hawaiian Electric, and Westar Energy are other electric utilities that look poised to outperform the market in 2015. A) Introduction The Utilities sector surprised many by posting the best price performance in the market in 2014. Electric utility companies were a particularly strong subset of the sector, posting an average gain of 31% during the course of the year. At this point, many investors are questioning whether the current rally will continue, especially with rising interest rates on the horizon (high interest rates hurt utilities). On Wednesday, Michael Purves, the head of equity derivatives research at Weeden & Co, advised investors to “start to take profits given the run is getting long in the teeth.” Contrary to common sentiment, we feel the sector’s momentum and growth should serve a signal of further outperformance, as the sector is still strongly undervalued relative to the overall market. Investors unfamiliar to our style of analysis should know that we solely look at metrics that have a long historical track record of predicting stock returns. We’ll first analyze how the overall Utility sector stacks up to the other nine sectors in ten metrics that have been academically shown to predict returns. Then, we’ll look into which stocks within the Electrical Utility industry group look poised to lead the group, again looking at value, momentum, and earnings. B) Top-Down Analysis of the Utility Sector In deciding whether to invest in certain utility stocks, it is critical to first look at how the overall sector stacks up relative to other sectors in value, momentum, and growth. The table below shows how the sector compares to other sectors in five valuation metrics that have been academically proven to predict returns: (click to enlarge) Source: QuantifiedAlpha.com The utilities sector looks the most attractive of any of the sectors on a book value basis, with the sector’s average price/book ratio of 2.22 being the lowest of any of the sectors. The sector looks relatively attractive on both a revenue and earnings basis, with a sales yield of 49% and earnings yield of 3.6%. Even with the big rally, the average utility stock pays a 3.4% dividend, good for third behind the Energy and Telecom sectors. Undervalued stocks tend to outperform the market, and using the average amount of excess return generated by these factors historically, our algorithms estimate how much. Overall, we expect the average utility stock to generate 1.31% of alpha attributable to value, over the next twelve months. Next, we analyze how the sector is doing on a growth & momentum basis: (click to enlarge) Source: QuantifiedAlpha.com As we said before, the utility sector has performed the best over the last twelve months, gaining 25% on average. It is the second best performing sector over the last six months, behind the Health Care sector, gaining a shade under 9%. The sector falls in the middle of the pack in average annual EPS growth, growing 18%. The sector is also in the middle of the pack in financial efficiency, returning an average of 2.8% on assets and 9.8% on equity. Each of these five metrics has been academically shown to predict stock returns, with the two price momentum metrics being the most important. Overall, we expect the average utility stock to generate 1.33% of alpha attributable to growth over the upcoming twelve months. C) Group Leaders Now that we’ve analyzed the sector on a top-down basis, we’ll now look at which stocks within the electric utility industry group look poised to lead the group. Below is a table showing which stocks in the group are the most undervalued: (click to enlarge) Source: QuantifiedAlpha.com As we can see, our top five most undervalued electrical utilities include Entergy Corporation (NYSE: ETR ), Exelon Corporation (NYSE: EXC ), Portland General Electric Company (NYSE: POR ), American Electric Power Co. (NYSE: AEP ), and Westar Energy (NYSE: WR ). Each of these companies has a sales yield (inverse of Price/Sales) over 45%, which is way above the overall market average. Each of these stocks sport similar earnings and dividend yields, each of which are again much higher than the overall market averages. These stocks also look attractive on a book value basis, with none of the company’s having a price/book ratio over 2. Overall, Entergy tops out as the value leader of the group, with our algorithms expecting the stock to generate 5.8% of value alpha over the next twelve months. With that being said, each of the five stocks is expected to significantly outperform the market due to their attractive value. Next, we’ll see which stocks are leading the sector in growth and momentum: (click to enlarge) Source: QuantifiedAlpha.com As we can see, our top five strongest growth electrical utilities include ITC Holdings Corp. (NYSE: ITC ), Hawaiian Electric Industries (NYSE: HE ), MGE Energy (NASDAQ: MGEE ), Northeast Utilities (NYSE: NU ), and Exelon Corporation. After a slow start to the year, Hawaiian has had a very strong second half of the year (+40%). Exelon has been the best performer over the past year, gaining 44%. Exelon has also had the strong EPS growth of the five, growing annual EPS by 41%. ITC Holdings tops the group in profit efficiency, returning 5.2% on assets and 21% on equity. Overall, ITC is expected to outperform the market the most owing to its growth profile over the upcoming twelve months (4.76%). Exelon is the only stock that made it onto both group leaders lists. Next, we’ll look at which stocks have been performing best relative analyst earnings expectations: (click to enlarge) Source: QuantifiedAlpha.com We’ve found through historical back testing that stocks that beat earnings estimates consistently, are extremely likely to keep beating estimates. This is crucial as stock prices can experience wild swings in price depending on how earnings come out relative to expectations. Hawaiian Electric has the best track record, having beaten EPS estimates by 12% last quarter (6 straight beats) and revenue estimates by 8% (2 straight beats). Edison International (NYSE: EIX ) has the best track record for EPS, having beaten the Wall Street consensus EPS estimates 8 times in a row. PPL Corporation (NYSE: PPL ), Westar Energy, and NextEra Energy (NYSE: NEE ) are names we haven’t seen yet, that have all outperformed expectations as well. D) Conclusion Now that we’ve analyzed the sector as a whole and the individual group leaders in the group, it is time to see which utility stock comes out on top. The table below shows the electric utility stocks we expect to outperform the market the most: (click to enlarge) Source: QuantifiedAlpha.com Exelon comes out on top on our list, with our algorithms expecting the stock to outperform the overall market by 8.73% over the next twelve months. Exelon combines strong value with solid momentum and EPS growth. Entergy, Hawaiian Electric, and Westar Energy are other stocks that were featured earlier in the article that also look very attractive. While American Electric Power is featured at #4 on our overall leader board, we advise investors to stay away from the stock as it has been missing analyst estimates recently (hence the one star Earnings Strength rating). Though the Utility sector outperformed the general market during 2014, we feel the sector is still relatively undervalued and certain names look very attractive.