Finding Bond-Like Income With Utilities

By Aaron Levitt | May 01, 2013 AAA

Given low paltry interest rates on traditional savings and income vehicles, investors have plowed into all manner of riskier higher yielding assets. One of the first parking places for income-seekers has been boring utility stocks. Known for its stable and high dividend yields, the sector became a prime choice for portfolios. As such, a plethora of money flowed in the traditionally boring industry.

That has some investors now worried about valuations.

However, despite the relative expensive nature of the sector today, utilities still offer one of the best income seeking values relative to their risk and dividend-size.

Still Quality In High Voltage

Delivering essential services such as water, gas, and electricity, utility companies have been a steady source of dividend income for decades. So it’s no wonder why they have been given the nod by many investors in the low rate environment. However, that’s caused some issues with their valuations.

Relative to the broader stock market, utility stocks are getting quite expensive. According to asset manager Fidelity, the utilities sector of the S&P 500- as represented by Utilities Select Sector SPDR (ARCA:XLU) – has gained about 15% this year. That compares to just a 10% return for the broad index. That extra returns have pushed power companies to valuations not seen in years. Currently, the Utes trade at P/Es of around 16- a premium of nearly 14% to the index. Historically, utilities have traded at P/E’s at a sharp discount to the market.

SEE: Profit With The Power Of The P/E Ratio

Yet, despite these higher valuations, the sector could still be a good bet for those seeking income. Mainly, because they are still quite attractive versus their main competitor: Bonds.

The sector is yielding 4.15% annually. That’s more than twice the 1.74% yield on a 10-year Treasury bond. Even moving down the notch to triple-B corporate bonds, Utes still yield more. Barclays Capital index of triple-B bonds yields just 3.1%. Even more amazing is that utility equities yield more than their own bonds. The iShares Utilities Sector Bond ETF (ARCA:AMPS) only pays 3.22%.

Meanwhile, the sector features bond-like low volatility. Even in times of uncertainty, consumers, businesses and municipalities still need to power their operations and cool their homes. Water still needs to flow and electricity hums through power lines. Ultimately, utilities' stable cash flows and recession resistant nature makes them ideal income candidates.

SEE: Trust In Utilities

Amping Up Your Dividends

With interest rates still next to zero, the utility sector continues to be a vital source of income for investors. An easy way to add that extra income is through the Vanguard Utilities ETF (ARCA:VPU). The fund tracks 78 different water, gas and electricity providers- including industry stalwarts like Duke Energy (NYSE:DUK) and Southern (NYSE:SO). The fund charges a rock bottom expense ratio of just 0.14% and yields a treasury beating 3.7%.

However, rich yields can also be found in individual utility stocks.

Take Wisconsin Energy (NYSE:WEC) for example. The multi-utility currently yields 3.1% and has been reliably paying dividends with bond like precision to shareholders since 1942. Those dividends have recently been strengthened as the firm reported better than expected earnings. Wisconsin Energy saw a rise in the consumption of electricity in the first quarter as well as adding an additional 3,000 electricity and 6,000 natural gas customers to its mix.

Another strong utility benefiting from strong demographics is Houston’s CenterPoint Energy (NYSE:CNP). The North American energy boom has benefited Texas and CenterPoint shareholders. The utility added 45,000 new customers- buoyed by "a continued strong Houston economy". CNP expects customer growth to increase by 2% for 2013. That growth in customers fueled impressive earnings and the company’s 3.4% dividend yield.

Finally, NextEra Energy (NYSE:NEE) could be one of the perfect examples of a growth utility. The company is one of the largest residential and industrial power providers in the Southern states, but it is also one of the largest generators of wind and solar power. The utility gives investors access to both mature markets and the growing demand for renewable energy. NextEra yields 3.3%.

SEE: Dividends Still Look Good After All these Years

The Bottom Line

As interest rates have been stuck at zero for some time, investors have clamored for all things yield. The traditional utility sector has become a happy hunting ground income seekers. That’s pushed valuations up to lofty levels. However, the sector still provides plenty of dividend growth and bang for investor’s bucks- especially when compared to bonds.

At the time of writing, Aaron Levitt did not own shares of any of the companies or funds mentioned in this article.

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