Under The Radar Utility Stocks

By Matt Cavallaro | October 21, 2011 AAA

Utility stocks have been the best performing sector in 2011 on a relative basis. The Utilities SPDR ETF (ARCA:XLU) is up 6.4% year-to-date, followed by the other defensive sectors (consumer staples and health care). The main reason is power companies drew safe haven bids in late summer as riskier stocks got pounded. Big utilities, while not as sexy as tech names, like Apple and Google, are still a very attractive option in the current environment for risk-averse investors in search of high yield and price stability. A hand full of lesser known utility stocks may offer better value, along with great dividends.

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Big Power Returns
Utility stocks tend to outperform when the market is under pressure. This year, while the S&P 500 has lost 2.5%, large-cap utility companies like Dominion Resources, Inc. (NYSE:D) and The Southern Company (NYSE:SO) are up 19.4 and 12.4%, respectively. These high yielding utility stocks remain good long-term investments in a well-diversified portfolio. Hot valuations - as a result of the strong year-to-date performance - may put a short-term ceiling in.

Instead, smaller regional utility stocks, that haven't risen as much as more well-known power providers, may be where the value is. For example, companies like Black Hills Corporation (NYSE:BKH) which has built a lot of momentum over the last few months. Similar to the big utility stocks, Black Hills pays an outstanding annual dividend yield at 4.5%. Black Hills is a diversified utility, servicing customers in South Dakota, Wyoming, Colorado, Iowa, Kansas and Nebraska.

In terms of value within the regionals, Avista Corporation (NYSE:AVA) stands out, featuring one of the cheapest price-to-earnings multiples. Avista, a provider of electric and natural gas services to customers in the northwestern United States, took a big hit following the second quarter earnings release. Higher than anticipated operating costs resulted in lower-than-expected earnings. But, there's underlying margin expansion happening at Avista Utilities. Last quarter, gross margins grew by $6.7 million due to general rate increases and higher retail loads. The stock rebounded sharply within days of falling sharply on the earnings miss, and has steadily trended higher since late September. Avista pays an excellent 4.4% yield, and is one of the better priced regional power companies with a big dividend. (For related reading on utilities, see Trust In Utilities.)

Sioux Falls, South Dakota-based NorthWestern Corporation (NYSE:NWE) is another solid utility that pays a great 4.3% yield. On a relative strength basis, NorthWestern's share price performance has been as strong as many large market cap utility companies. NorthWestern provides services to customers in South Dakota, Nebraska and Montana. One area where NorthWestern has a clear advantage is a more manageable debt load, compared with Black Hills and Avista.

The Bottom Line
There's a lot of companies in this group to like with the winds of winter approaching, and increasing seasonal demand for utility services. However, it's important to watch the weather; warmer temperatures during the typically cooler seasons translates into less electricity and gas usage, and it's been unseasonably warm fall thus far. Also, keep an eye on capital expenditures and debt levels for these utilities.

At the end of the day, the primary reason to avoid utility stocks - low growth as a result of heavy regulation - is not a significant factor right now. Even though utility stocks offer lower growth prospects, compared with less regulated industries, the growth that utilities are generating is much more dependable because of the necessity of services they provide. This stability is a big reason why utilities have outperformed the market by such a wide margin this year. Additionally, with bond yields at historic lows, the big yields utility stocks offer appear even more attractive. There are a number of outstanding regional utility companies executing on their strategic plans, and rewarding investors with steady, reliable dividend growth to choose from. (For related reading, see Utilities: A Better Choice Than Bonds.)

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