Submitted by
Investing
Daily
as part of our
contributors program
.
By: Roger Conrad
Utilities weren't always paragons of strength, as anyone who
remembers the implosion of Enron 11 years ago can attest. And it's
a safe bet some companies will get tripped up by inadequate
planning for capital needs and/or deteriorating regulatory
relations in 2013. Below, I highlight three themes that could help
you with your utility investment decisions going into 2013.
#1 Don't Fret Rising Interest Rates
Wall Street wisdom holds that
utilities
and other dividend-paying stocks are interest-rate sensitive. As a
result, many fear a meltdown when today's historically low rates
turn higher.
Ironically, the so-called link between benchmark interest rates
and dividend-paying stocks is basically non-existent. From June 30,
2008, to March 9, 2009, the Dow Jones Utility Average crashed from
above 500 to less than 300.
Bonds, however, had one of their most explosive rallies in
history, with the yield on the benchmark 10-year Treasury note
falling from 4 percent to barely 2 percent.
Treasuries and dividend-paying stocks also moved in opposite
directions during the Flash Crash of mid-2010, the Debt Ceiling
Crisis of summer 2011 and this year's spring growth scare.
Market relationships are constantly being forged and torn
asunder. But dividend-paying stocks have been moving independent
and opposite of shifts in interest rates for some time. And there's
no reason to expect they won't keep acting like stocks rather than
bond substitutes going forward.
They're economically sensitive, not rate sensitive.
#2 Dominance of AT&T and Verizon Will
Persist
Last month
Deutsche Telekom AG
(Germany: DTE, OTC: DTEGF, ADR: DTEGY) announced its T-Mobile USA
unit would buy
MetroPCS Communications Inc
(
PCS
). A consummated deal would create an entity with 42.5 million
subscribers and about 12 percent of the US wireless market.
Barely a week later
SoftBank Corp
(Japan: 9984, OTC: SFTBF, ADR: SFTBY) agreed to buy 70 percent of
Sprint Nextel Corp
(
S
), vowing to revive America's third-largest wireless company.
Some have hailed these deals as game-changers for the US
wireless industry, "disrupting" the emerging duopoly of
AT&T Inc
(
T
) and
Verizon Communications Inc
(
VZ
).
Reality is likely to prove less than spectacular.
SoftBank is providing badly needed cash to Sprint and has
experience competing against larger companies in its native Japan.
But the $8 billion it will eventually push to Sprint may not go
that far considering the latter's $23.7 billion debt and a $15.5
billion obligation to buy iPhones from
Apple Inc
(
AAPL
).
Moreover, Sprint is still losing ground rapidly, shedding
459,000 contract customers during the third quarter. That's its
first drop in subscribers since early 2010. And many of those users
no doubt left for Verizon, which reported a gain of 1.5 million of
such valuable connections. The company's loss was less than
expected, but only because it cut spending and sold fewer
iPhones.
The Federal Communications Commission (FCC) is likely to approve
both deals next year. And T-Mobile USA particularly could see an
immediate benefit, as it becomes a force in the lower-end pre-paid
wireless market.
Those expecting an immediate sector shakeup are likely to be
disappointed, particularly in light of third-quarter numbers
showing AT&T and Verizon widening their lead in users and
network quality.
That's good reason to continue steering clear of Sprint and
Deutsche Telekom until today's hype is matched by deeds.
#3 Watch out For Hawkish Regulators
One trend likely to continue in some states, post-election, is
the ongoing reduction in utility return on equity (ROE).
ROE is supposed to set rates to allow a fair return on
investment in light of companies' cost of capital. And given the
drop in borrowing rates to historic lows, there's some
justification for reducing ROEs in the current environment.
Inevitably, however, some states are using ROEs as a tool to
keep rates low in a soft economy without having to officially
disallow investment. The immediate result is lower earnings and,
eventually, diminished reliability and ability to invest.
Washington State-based electric and gas company
Avista Corp
(AVA), for example, recently reached a settlement of its rate case
with an ROE of just 9.8 percent. That's against an initial request
for 10.9 percent.
Worse,
Pepco Holdings Inc's
(POM) widely panned performance during last summer's outages earned
it the unenviable moniker of "worst company in America" in a recent
survey. That unpopularity is now hitting the bottom line.
Last month District of Columbia regulators cut the company's ROE
to just 9.5 percent. Settlements in Delaware and New Jersey would
reduce ROE to just 9.75 percent, lower if regulators reject
them.
Finally, Maryland regulators cut ROE to just 9.31 percent this
summer, a number they could take even lower in an ongoing rate
case, even as they impose punitive action for summer storm
performance.
Fortunately, most utilities aren't nearly so vulnerable.
Regulatory relations are still solid in most states, including
some, such as Nevada, still smarting from high unemployment.
Meanwhile, companies operating in less-hospitable states such as
Connecticut and New York are limiting risk by avoiding rate cases
for now.
Lower ROEs are a sobering reminder of how important a positive
regulator-utility relationship is to shareholder returns.
Pepco's setbacks are a good reason to avoid its shares, and stay
away from those of any other company that runs afoul of those who
set its rates. For 6 more utility stocks to avoid, see my
Income Investor's Blacklist
.