Is Utilities’ Fall the Sound of the Silent Canary?
Electric utility stocks are in a downward spiral, and that’s raising two of Wall Street’s least favorite questions: Have interest rates bottomed? And is the bull market on its last legs?
The Dow utility stock index sank 1.45 points to 241.76 on Tuesday, its lowest close since late June. The index has lost 5.7% since peaking at 256.46 in mid-September, while most other major stock indexes have either moved sideways or run up to new highs.
The damage among individual utility issues has been significant: SCEcorp, parent of Southern California Edison, has dropped from $25.75 in September to $21.875 now, a 15% loss. Detroit Edison stock is off 10.4% from its peak and Niagara Mohawk in New York is down 11.8%.
Historically, investors have been heavy buyers of these stocks when interest rates are falling, because the utilities’ hefty dividends offer a good yield alternative to bank CDs or bonds. Conversely, when rates start to rise, the utilities often are the first stocks to be dumped.
Their sensitivity to rates has given utilities a sort of “canary in a coal mine” status on Wall Street: A peak in utility stocks frequently foreshadows a broad bear market by six to nine months.
What is baffling analysts is that the utilities have weakened even though interest rates in general have been flat to down since mid-September. The yield on five-year Treasury notes, for examples, is at 4.64% now, down from 4.81% on Sept. 20. Longer-term yields also have eased and remain near 20-year lows.
Do utility investors know something the bond market doesn’t? Some analysts doubt it. Edwin Bragdon, manager of the utility-heavy Eaton Vance Total Return stock fund in Boston, argues that interest rates are more likely to go lower than higher from here. He cites continuing declines in rates overseas and a subdued inflation outlook in the United States, where the sluggish economy has made it impossible for most companies to raise prices much if at all.
The utilities’ selloff, Bragdon notes, has left stocks such as SCEcorp sporting annualized dividend yields of 6.5%. With the yield on 30-year Treasury bonds at just 5.92%, SCEcorp “is an attractive security,” Bragdon contends. “I doubt it can go much lower.”
Gene Seagle, an analyst who studies the broad market for brokerage Gruntal & Co. in Stamford, Conn., says, “It may be that the drop in (utility) stocks has very little meaning at all” beyond simple profit taking that hits now and then.
Indeed, investors in these stocks have good reason to take a little money off the table. At its peak in September, the Dow utility index was up 16% from Jan. 1. Even with the recent decline, the utility index is still up 9.4%, compared to an 8.8% rise in the Dow industrials.
Analysts also note that utilities could be suffering from temporary competition from other securities: A surge in new real estate investment trusts (REITs) has hit the market in the last few months, and Bragdon says Wall Street will try to bring $5 billion in REITs public by year’s end. The trust shares often promise 7% dividend yields and, like utility stocks, offer the potential for rising dividends over time.
But Barry Abramson, utility analyst at Prudential Securities in New York, says the electric companies are suffering from more than mere profit taking and competition from other investments.
“The fundamentals of the industry are getting worse, not better,” he argues. Public utility commissions have been cutting the companies’ allowed returns on equity as market interest rates have dropped, Abramson notes. (The regulators typically use bond yields as a benchmark when deciding what utilities should be allowed to earn on their capital investment.) That is reducing earnings expectations for 1994 and beyond. And as earnings estimates come down, so do hopes for dividend hikes next year.
For example, Abramson believes SCEcorp. will earn $1.70 a share from operations (i.e., before onetime write-offs) this year, down from $1.75 a share last year. For 1994, he sees earnings flat at $1.70. With a current annual dividend of $1.42 a share, SCE is already paying out 84% of its earnings in dividends. That will make it difficult for management to raise the dividend much if at all in 1994, Abramson says.
For the electric utilities as a whole, Abramson sees dividends rising just 1.5% next year, down from a 2% projected rise this year and the smallest annual increase in 30 years.
Investors may not necessarily see rising interest rates on the horizon, Abramson says, but they’re smart enough to realize that utility stocks have had a tremendous run over the last decade and that eventually the cycle has to turn.
With the fundamentals looking lousy, Abramson is reluctant to suggest that investors consider this dip a good opportunity to buy in. It may be smarter to look elsewhere--especially if you expect the economy to improve in 1994, raising the chances of higher interest rates.
Power Shortage Electric utility stocks have been sinking for the last month, which some analysts fear is a foreshadowing of higher interest rates.
Drop 1993 Tues. from Div. Stock high close high yield Centerior Energy 20 16 3/4 -16.3% 9.6% SCEcorp 25 3/4 21 7/8 -15.0% 6.5% Niagara Mohawk 25 1/2 22 1/2 -11.8% 4.4% Puget Sound P&L; 29 3/4 26 1/2 -10.9% 6.9% Detroit Edison 37 1/8 33 1/4 -10.4% 6.2% Texas Utilities 49 3/4 45 7/8 -7.8% 6.7% Consol. Ed. N.Y. 37 3/4 35 1/4 -6.6% 5.5% Amer. Elec. Power 40 3/8 38 -5.9% 6.3% Pacific G&E; 36 5/8 35 3/8 -3.4% 5.3% Dominion Resources 48 7/8 47 1/2 -2.8% 5.2% Dow utilities 256.46 241.76 -5.7% 5.5% S&P; utilities 189.49 180.80 -4.6% NA
All stocks trade on NYSE.
