Go on Defense with High Yielding Utility Stocks

The latest chapter in the never-ending saga of “Can the Greeks Pay their Bills” adds another brick in the wall of worry for Aussie investors.  In reality many analysts claim a Greek Exit, or Grexit, from the Eurozone and/or the European Union will matter little.

Add the Grexit to current concerns about our economy and it would seem a good time to start playing defense.

To begin we looked at ASX Sector performance year over year through 2 July 2015.  Here is what we found:

•    Healthcare        (XHJ)    +30%

•    Telecommunications    (XTJ)    +20%

•    A-REITS               (XPJ)    +18%

•    Industrials        (XNJ)    +15%

•    Utilities            (XUJ)    +10%

If you have considered defensive stocks before you will notice the absence of the Consumer Staples Sector from the list.  You know the argument.  People need to eat.  Yet the ASX Consumer Staples XSJ is actually down 12% year over year.

Historically Telecommunications Sector Stocks have been considered defensive but one could make a strong argument that things have changed.  Telco revenue streams now include discretionary items like highly-priced cable television and mobile data packages.

The Industrial Sector is sub-categorized into Capital Goods, Transportation, and Commercial and Professional Services; all of which are subject to corporate cost-cutting efforts in tough times.

A-REITS are doing well but again tough economic times can drag down occupancy rates for commercial and retail properties.  Add to that concerns over the residential property market and it seems defensive investors should look elsewhere.

Many Healthcare Stocks can be considered defensive but we think the best defensive sector right now is the XUJ Utilities Index. Why?  The ideal defensive stock is one with high dividend yields and low volatility, as measured by a statistical value called Beta.  A Beta value under 1 indicates less gyration in the price of the stock.  The Healthcare Sector has the lowest average Beta at 0.51, followed by Utilities at 0.76.  However, on average dividend yield for the sector, Utilities bests Healthcare by a wide margin – an average 5.4% yield for Utilities versus 2.6% for Healthcare. Finally, some healthcare issues can be postponed but consumers and commercial businesses alike cannot function without electricity and gas.

We searched for the highest yielding Utility stocks with the added benefit of franking privileges to juice up shareholder returns.  As you know, current yield alone can lead investors astray, so we looked at historical performance for dividends as well as future forecasts for both dividends and earnings.  With these admittedly tough criteria, we found five stocks that measured up.  Here is a table ranked in alphabetical order.

First note that all five stocks have low Beta values.  In theory this means the stock price should fluctuate less than some stocks in a high Beta Sector like Energy, with an average Beta of 1.19.  In practice, volatility is sometimes in the eye of the beholder.  The following price movement chart compares the two stocks with the highest Beta’s, ERM Power (EPW) and AusNet Services (AST).

AusNet Services provides electricity and gas through its own distribution networks in the state of Victoria.  The company has been a dividend powerhouse for some time but skeptics are beginning to question AusNet’s ability to sustain its dividends, despite a two year growth forecast of 2.2%.  The outsized earnings growth forecast of 70.1% seems to contradict that concern, but the jump is coming off a low base.  Earnings per share (EPS) dropped from $0.07 in FY 2014 to $0.024 in FY2015.  The forecast calls for EPS at $0.084 in 2016, dropping to $0.07 in 2017.

The company reported a slight revenue increase (+1.9%) in its March release of Full Year 2015 results, but net profit after tax (NPAT) fell 87.3%.  However, the profit drop was attributed to a variety of one-off factors and management guidance called for not only a dividend increase, but also an increase in franking credits.  Supposedly, a restructuring plan will make this possible.  AST has a forward P/E of 20.01, which compares favorably to the current Sector P/E of 26.45.

Energy Developments (ENE) owns and operates power generation facilities in Australia, the United States, and Europe.  It generates “clean” energy, using LNG (Liquefied Natural Gas); CNG (Compressed Natural Gas); Landfill Gas; and Waste Coal Mine Gas.  Energy Developments serves large scale corporate customers and remote locations.

Energy Developments has an analyst consensus rating of Outperform, with 2 Buys, 4 Outperforms, and 1 Hold.  The company’s reported EPS for FY 2014 was $0.29. There are some 7 analysts covering the stock with an average EPS estimate for 2015 of $0.36 for FY 2015 and $0.46 for 2016.  ENE trades about 60 thousand shares a day, compared to close to 4.5 million for AusNet, suggesting this company has yet to make it onto the radar screens of many investors.

ERM Power (EPW) and Pacific Energy (PEA) have been paying dividends less than five years, so we have no averages or growth rates for them. However, EPW increased its first year of dividend payments of $0.09 per share to $0.12 per share in FY 2014.  PEA paid its first full year dividend of $0.01 per share in 2013 which more than doubled to $0.025 in FY 2014.

ERM Power deals exclusively with business and government customers with its gas-fueled electricity generation operation and reportedly is the fourth largest seller of electricity in the country.  ERM is actively expanding into the SME (Small and Medium Enterprises) market.  On 11 December 2014 the company announced the acquisition of a US electricity retailer and as of 23 January secured regulatory approval, paving the way for entry into the US market.

Half Year 2015 Results showed a 13% revenue increase and a 113% rise in underlying profit.  The company has an Outperform analyst consensus rating, with 3 analysts at Buy and 1 at Hold.

Ethane Pipeline Income Fund (EPX) is another under the radar investment, trading only 35 thousand shares per day.  The company has one customer and one operating asset – a pipeline that transports ethane gas for use in producing polyethylene.  EPX has the highest current dividend yield and the highest five year average yield, but investors should note dividend payments have declined in the last three years, from $0.162 per share in FY 2012 to $0.154 in 2013 and $0.127 for FY 2014.

The final stock in the table is the only one with a negative return year over year.  Pacific Energy (PEA) also qualifies as an under the radar stock, averaging just 20 thousand shares traded a day over the last three months.  Looking at the company’s revenue and profit performance over the last three years makes the share price decline somewhat puzzling.  Revenues grew from $32.9 million in FY 2012 to $49 million in FY 2014 while NPAT rose from $1.4 million to $16.2 million.

The answer might rest in the power generation operation Pacific management claims is the company’s flagship project – Kalgoorlie Power Systems.  This project includes 19 company designed, built, operated, and maintained power stations in Western Australia, Southern Australia, and the Northern territories.  The problem may be that these stations serve remote mine and ore processing sites.  It is possible investors stop reading at the mention of “mines and ores” and fail to realize the majority of these power stations serve gold miners, not iron ore miners. A visit to the company’s website shows mining customers in gold, nickel, manganese, rare earth minerals, and mineral sands with not a single iron ore miner among them.

Pacific also operates two hydro-powered electrical generation stations in Victoria.  The company has only one analyst covering the stock with a Strong Buy recommendation. On 1 December 2014 Pacific’s Managing Director announced his resignation and the share price has been falling ever since.  Here is a one year chart for PEA.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.