Your Money : Electric Utility Stocks Continue a Headlong Slide

Once the epitome of conservative investing, electric utility stocks are in the midst of their most severe bear market in 20 years. And many analysts say the worst is yet to come.

So if you’re a bargain hunter, this is not the place to shop--despite dividend yields of 7% to 10%. Long-time owners of these shares may want to consider selling. Investors in utility mutual funds, however, may be OK staying put, depending on your goals and your fund’s mix of stocks.

The plunge in utilities began last fall, as interest rates began to creep up. Because utilities, by virtue of their fat dividends, compete with bonds for investors, they are hostage to bond yields. If those yields go up, utility yields must rise as well. And the fastest way for the market to adjust a stock’s dividend yield is to push the share price down.

After reaching an all-time high of 256.46 in September, the Dow Jones utility stock index entered a slow decline that took it down to 229.30 by year’s end, a drop of 10.6%.

This year, as interest rates have rocketed on fears about the economy’s strength, the utility index’s slide has accelerated. And in recent weeks a new worry has emerged to pressure the stocks: Growing fears about future deregulation of the industry--and how the winners and losers might sort out when utilities can compete to send power to each others’ now-monopolized regions.

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The bottom fell out of the stocks this week after Florida utility FPL Group announced on Monday that it would slash its dividend 32%. FPL, a healthy utility that had no overriding reason to cut its dividend, did so in part to prepare for the new era of deregulation, the company said.

Fearing that a wave of dividend reductions is imminent, investors dumped utility stocks across the board this week. The Dow utility index, 188.83 a week ago, closed Thursday at 177.76. From its fall peak, the index has now lost a stunning 31%.

Doesn’t that make many of the stocks screaming buys? After all, most of the companies probably won’t cut their dividends. And with the yields the stocks now are sporting, it may be hard to imagine that there isn’t a decent long-term payoff here. Houston Industries shares, for example, yield 9.8% now: a $3-a-share annual dividend on a stock priced at $30.75. Pacific Gas & Electric’s yield is 8.5%; New York’s Con Ed yields 7.3%.

Barry Abramson, a veteran utility analyst at Prudential Securities in New York, agrees that the yields look tempting. But he is advising clients to stay away from virtually all of the stocks.

Why? Abramson says the stocks’ declines so far have been almost exclusively the result of the rise in market interest rates. To stay competitive with bond yields, utility stocks have had to fall 14% for every one-point rise in long-term bond yields. With bond yields up 1.75 points since October, Abramson figures that 25 points of the 31% drop in the Dow utility index since is rate-related.

That means that the fundamental concerns dogging the industry--specifically regarding deregulation--have shaved only 6% from the average utility stock price. That isn’t enough to reflect the risks involved, Abramson argues.

Even if bond yields stabilize or decline from here, he says, buyers won’t automatically come back to utility stocks because of looming deregulation. California regulators started the clock ticking in April, when they opened for discussion the issue of unfettered competition.

While real competition is years away, FPL’s decision to make a “preemptive” dividend cut was a powerful sign that utility managers are already preparing for what might come, Abramson says.

The way Abramson sees it, most utilities are backed into a corner on their dividends, because they already pay out 80% (on average) of earnings in dividends. If earnings decline even slightly at some utilities because of rate cuts related to new competition, there may be little profit left after paying stockholders their dividends. Hence, the choice becomes starve the company of profit--or cut what you share with stockholders.

It’s still too early to say for sure which companies’ dividends are safe, Abramson says. But if your utility is paying out more than 80% of earnings in dividends, think about how you’d feel if the dividend were cut, he says. If you couldn’t handle the drop in income, it may be time to move into fixed-rate bonds or other, safer investments.

What about utility stock mutual funds? Thanks to their diversification, you don’t have the same risk of a sharp decline in dividend income, overall, as you would with an individual stock. Moreover, many utility funds own not only electric companies but phone and gas companies as well. Many of the funds also have diversified into foreign utilities.

While hanging on to utility funds may not carry severe risk, however, you should also realize that the salad days for these funds are over. With interest rates more likely to rise than fall in the years ahead, and with electric utility dividend growth all but halted, returns on the funds may be disappointing at best for several years.

Utility Funds’ Dive How some of the biggest utility stock mutual funds have fared since 1992:

Total return: Fund ’92 ’93 ’94 Franklin Utilities +9.1% +11.5% -16.8% Colonial Utilities A +21.0 +9.3 -13.9 Dean Witter Utilities +8.8 +12.8 -11.5 Vanguard Sp. Utilities NA +15.1 -11.0 Invesco Utilities +10.8 +21.2 -10.9 Liberty Utility A +9.1 +15.1 -9.0 Prudential Util. B +9.0 +15.3 -8.6 IDS Utilities Income +11.3 +19.4 -8.2 Fidel. Utility Income +10.9 +15.6 -5.7 Avg. stock fund +8.9 +12.5 -3.0

Source: Lipper Analytical Services