Utility Stocks May Stall Amid Tech Rebound

Electric utility stocks, driven by strong power demand, falling bond yields and defensive-minded investors, have had a remarkable year so far.

The Dow Jones utility stock index is up 36% year to date, while most U.S. blue-chip indexes are in the red.

But in recent weeks many utility stocks have flattened. California’s current power crisis notwithstanding, analysts note that we are headed into the part of the year when electricity demand slackens.

Is the utility sector played out for now? Is it time to take profits and move on?

Experts who follow electric utilities say much depends on the rest of the stock market. It’s no accident that major utility indexes hit bottom in the second week of March, just as the tech-dominated Nasdaq composite index was soaring to its all-time high.

Now, if tech stocks continue to recover from their spring and summer collapse, that could divert money from utility shares, analysts say. When a traditionally exciting sector like tech is red-hot, nobody wants to hear about utility stocks, said Doris Kelley-Watkins, portfolio manager of the Evergreen Utility Fund.

Many investors who initially piled into utility issues in winter and spring were seeking a safe haven as Nasdaq plunged: With their high-dividend yields, big utility companies have long been favorite defensive plays.

But then came the summer peak power-use season, and the country woke up to the reality of an electricity shortage. Utility stocks zoomed. The terrific gains “were a real boon to investors who came here thinking they were going to be bored,” Kelley-Watkins said.

Indeed, stocks of firms such as Dynegy (ticker symbol: DYN), Calpine (CPN), Reliant Energy (REI) and Duke Energy (DUK) are up more than 70% so far this year.

Kelley-Watkins, like a number of Wall Street analysts, believes that the “easy money” in utility stocks already has been made. Nevertheless, there will still be opportunities in the sector as long as generating capacity stays tight--which it is sure to do for at least two or three more years, she said.

Some new power plants will be coming online toward the end of 2002, Kelley-Watkins added, but the current supply squeeze has been more than a decade in the making and will not be quickly solved.

Hence, some of the biggest gainers this year are utilities that have extensive energy-trading operations--Duke and Reliant, for example. They could continue to take advantage of soaring demand and unusual volatility, Kelley-Watkins said.

Dynegy and Houston-based Enron (ENE), the nation’s biggest wholesale power marketer as well as a major trader of natural gas and other commodities, are among the Evergreen fund’s biggest holdings.

Kelley-Watkins also thinks that Sempra Energy (SRE), parent of San Diego Gas & Electric, has made a good transition from a heavily regulated owner of power plants to an energy distributor and transmitter. But she shies away from Sempra’s giant California cousins, PG&E; (PCG) and Edison International (EIX, parent of Southern California Edison), which she considers too debt-burdened.

Nobody welcomes a recession, but Timothy M. Winter, analyst at A.G. Edwards in St. Louis, said an economic downturn probably would help utility stocks, as many remain relatively cheap in terms of price-to-earnings ratios, and would continue to be viewed as a defensive haven.

The presidential election outcome also matters, Winter said. Most Wall Streeters think a George W. Bush victory would be a plus for the sector because he probably would be more open than Al Gore to new power plant construction.

Winter likes Progress Energy (PGN), formerly Carolina Power & Light, because of its dominance in the fast-growing Southeast. His firm also recommends American Electric Power (AEP) and Xcel Energy (XEL).

Michael S. Worms, analyst at Gerard Klauer Mattison in New York, said although electric-utility earnings should continue strong into next year, it will be hard to duplicate this year’s 20% average profit gains. “We had a phenomenal year because of tight capacity and high prices,” Worms said.

Utility stocks probably would have done well on such business fundamentals, but they also received a strong tail wind from the stumbling tech sector, said Worms.

If tech shares have bottomed, and if the Federal Reserve speeds the market’s recovery with interest-rate cuts, that will hurt the performance of utility stocks, Worms said.

His top pick is Calpine, even though shares of the San Jose-based energy generator and marketer already have had an amazing two-year run, up 200% so far this year, on top of a 400% surge in 1999.

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Running Low on Power?

Utility stocks surged in spring and summer, but the group has stalled

in recent weeks.

Dow Jones index of 15 major utility stocks, weekly closes and latest

Monday: 386.41

Source: Bloomberg News