Utilities: A Better Choice Than Bonds

By Aaron Levitt | August 09, 2011 AAA

Despite that fact the U.S. debt was downgraded, investors have flocked to them in spades as the market turmoil has set in. Yields on 10-year U.S. Treasury notes have now fallen to their lowest rates in years as investors have sought to protect themselves from the market maelstrom. However, with funds like iShares Barclays 7-10 Year Treasury (NYSE:IEF) now barely yielding more than inflation and the broad equity markets selling for bargain prices, a traditional income sector is looking pretty juicy by comparison.

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Finding Yield in High Voltage
With Treasury yields now sitting near the December 2008 record-low of 2.04%, investors in bonds are now facing a quandary; balancing safety with income needs. The recent market rout has now opened up some opportunities in traditional income sectors. The utility sector might offer the right combination of growth, safety and dividends that is now escaping bonds. 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 candidates for investing during uncertain times.

Before the crash, the sector was a strong performer. As retiring Baby Boomers looked for ways to pay the cable bill and buy a few rounds of golf or a new iPad, utility stocks were filling the void. Through July 15, the broad-based Utilities Select Sector SPDR (NYSE:XLU) was up around 6.5% versus a 5% increase for the S&P 1500. However, utility stocks that were still cheap on historic P/E basis before the recent crash are roughly where they were at the start of 2011.

More importantly, utilities could be providing a nice bit of growth in addition to their income potential. The record heat wave this summer has pushed up usage rates and any uptick in the economy will benefit power producers even more. Finally, many utilities have begun the process of upgrading their power plants and increasing their use of renewable energy sources. The smart grid build-out has also spurred investment in new transmission lines and technologies, which has upgraded utilities' stodgy image. These advances will ultimately help income seekers as utilities boost future profits and dividends.

Water, Gas and Electric Payouts
Funds like the Vanguard Utilities ETF (NYSE:VPU) and iShares S&P Global Utilities (NYSE:JXI) make ideal choices for gaining broad exposure to the sector. However, given the plethora of choices available in the sector, investors can find bigger dividend yields and more growth in individual stocks. Here are a few picks.

Operating in several key oil-producing states, including heat stricken Texas, analyst point to American Electric Power (NYSE:AEP) as a strong contender for a utility portfolio. Currently, AEP yields 5.2%, but has been pretty successful at receiving rate increases for its operating area. In addition, the company has yet to make large investments into smart grid operations, which could provide the utility some extra oomph when it does.

As some municipalities struggle with budget cutbacks, many are privatizing their water authorities. This shift has benefited water utility Aqua America (NYSE:WTR) which has been quite successful in adding these assets. The firm added 23 different small water authorities in 2010. Currently, Aqua yields 3%. Investors may also be interested in competitors American Water Works (NYSE:AWK) and California Water Service Group (NYSE:CWT), which yield 3.3% and 3.4%, respectively.

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 4.2%.

The Bottom Line
With investors seeking safety in treasury bonds, the yields on certain traditional equity income sectors are at juicy levels. The utility sector can provide big dividends, safety and growth. The previous stocks along with funds like the Rydex S&P Equal Weight Utilities (NYSE:RYU) are a great bet for the months ahead. (Take a trip through history to learn from some (in)famously frugal Scots. Check out Save Money The Scottish Way.)

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