If there was ever a contrarian trade for 2017, it would be the power-generating utility stocks. The sector had a huge run in 2014 and 2015 as investors crushed by low interest rates ran to the sector for safe dividend yields. But as rates started to creep higher in 2016, and with the specter of looming Federal Reserve increases, the selling started, and it was big.
Needless to say, despite the sector going out of favor, power generation is still a crucial infrastructure need for everybody in the United States, whether it be at home or for business. A new SunTrust Robinson Humphrey research report makes the case that there is still some value in the sector and offers five top ideas for this year that makes sense for more conservative accounts. All are rated Buy.
American Electric Power
This industry leader is also a solid dividend-paying company. American Electric Power Co. Inc. (NYSE: AEP) is one of the largest electric utilities in the United States, delivering electricity to more than 5.3 million customers in 11 states. It ranks among the nation’s largest generators of electricity, owning nearly 38,000 megawatts of generating capacity in the United States. It also owns the nation’s largest electricity transmission system, a more than 40,000-mile network that includes more 765 kilovolt extra-high voltage transmission lines than all other U.S. transmission systems combined.
Many on Wall Street feel that the stock trades at a discount to its utility peers and they feel it deserves a premium. The analysts note the company has a less volatile earnings stream, and they see the potential for earnings upside due to changes in legislation in Ohio. Also trading at a discount to peers could lead to a premium valuation.
AEP shareholders receive a 3.8% dividend. The SunTrust price objective for the stock is $81, and the Wall Street consensus target is $67.03. Shares closed on Tuesday at $62.12.
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AES
This company is an off-the-radar choice that has solid upside potential from current levels and is a top mid cap pick at SunTrust. AES Corp. (NYSE: AES) owns and operates power plants to generate and sell power to customers, such as utilities, industrial users and other intermediaries. The company also owns and operates utilities to generate or purchase, distribute, transmit and sell electricity to end-user customers in the residential, commercial, industrial and governmental sectors. It also generates and sells electricity to the wholesale market.
AES uses a range of fuels to generate electricity, including natural gas, coal, hydro, wind, energy storage, oil, diesel, petroleum coke, biomass, landfill gas and solar. The company owns and operates a generation portfolio of approximately 29,352 megawatts. It has operations in the United States, Chile, Colombia, Argentina, Brazil, Mexico, Central America, the Caribbean, Europe and Asia.
The analysts note that the company trades at a 26% price-to-earnings multiple discount to peers in the sector. They noted this in the report:
After 3 years of flat / declining earnings, earnings growth should align with cash flow (and dividend) growth, driven primarily by projects currently in construction. Resolution of Ohio regulatory application (expected in the first quarter of 2017) should provide visibility to earnings growth outlook.
AES shareholders receive a 4.25% dividend. The $15 SunTrust price objective compares with the consensus target of $12.34. The stock closed at $11.33.
Dynegy
This is the SunTrust top small cap pick, and it makes sense for investors not needing dividend income but looking for safety and solid capital gains potential. Dynegy Inc. (NYSE: DYN) operates in three segments, Coal, Illinois Power Holdings and Gas. The company sells its services on a wholesale basis from its power-generation facilities. It has a fleet of 35 power plants in eight states, totaling approximately 26,000 megawatts of generating capacity.
The company serves a range of customers, including regional transmission organizations, independent system operators, integrated utilities, municipalities, electric cooperatives, transmission and distribution utilities and power marketers, as well as financial participants, such as banks and hedge funds, and residential, commercial and industrial end-users.
The analysts noted in the report:
We expect completion of debt restructuring in the first quarter of 2017; translates into $3 per share of incremental equity value (factored into our valuation analysis). Additional asset sale announcements should highlight underlying equity value and aid further debt reduction.
Dynegy currently does not pay a dividend. SunTrust has a $14 price target. The consensus target is $13.92, but shares closed on Tuesday at $9.32.
Edison International
This top utility continues to raise its dividend regularly. Edison International (NYSE: EIX) generates electricity through hydroelectric, diesel, natural gas, gas fueled, combustion turbine, nuclear and photovoltaic sources. It supplies electricity primarily to residential, commercial, industrial, agricultural and other customers, as well as public authorities through transmission and distribution networks.
Edison International remains well positioned to compete in the market place. The company says that the billions it is spending on upgrades goes predominantly to its networks, and that it only owns about 15% of the generation that its customers consume. The other 85% is purchased on the open market.
The analysts cited these solid reasons to own the stock:
Dividend payout ratio has room to increase, implying that dividend growth should be greater than earnings growth (dividend change announcements are normally made in December). The stock currently trades at a 3% P/E multiple discount to the peer group (based on our 2018 estimate); above average earnings and dividend growth, coupled with elimination of regulatory overhang, should lead to premium valuation.
Investors are paid a 3.06% dividend. SunTrust has set its price objective at $81, and the consensus target is $76.71. Shares closed Tuesday at $71.11.
Exelon
This top utility stock also still makes good sense now for conservative accounts and could beat earnings estimates. Exelon Corporation (NYSE: EXC) is the nation’s leading competitive energy providers, with 2015 revenues of approximately $29.4 billion. Headquartered in Chicago, Exelon does business in 48 states, the District of Columbia and Canada.
Exelon is one of the largest competitive U.S. power generators, with approximately 32,500 megawatts of owned capacity comprising one of the nation’s cleanest and lowest-cost power generation fleets. Exelon’s utilities deliver electricity and natural gas to more than 7.8 million customers in central Maryland, northern Illinois and southeastern Pennsylvania.
The company’s Constellation business unit provides energy products and services to more than 2.5 million residential, public sector and business customers, including more than two-thirds of the Fortune 100.
Exelon investors receive a 3.63% dividend. The $41 SunTrust price target compares with the $37.81 consensus target. The stock closed Tuesday at $35.06.
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The halcyon days of huge gains for the sector are over, but it always makes sense to keep a weighting of utility stocks in a well-rounded portfolio. This is also a solid contrarian play, and the stocks should hold up well when the long-awaited correction finally shows up.
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