As the market begins to roll over, it becomes increasingly important to protect your portfolio. Of course, we advocate holding precious metals, like gold, that will hold their value in both inflationary and deflationary times – but some well positioned stocks should remain cornerstones of your portfolio as well. This type of company should boast a fundamentally stable business and a dividend stream to cushion investors in tough times, but also an element of growth that rewards investors in better times.
In the current market, some utility companies fit the bill. Withthe Obama Administration and the Federal Reserve pulling out all the stops to keep interest rates low, and many utility yields look attractive at current levels. Add in that a market pullback will likely initiate a flight to safety, and selected utilities could also offer substantial capital appreciation.
We don’t recommend going out and buying utilities at will, however, as all are certainly not created equal. Most will provide nice income streams, but the growth of that stream is largely tied to regulated rate increases. As we enter an exceptionally inflationary era, with interest rates rising (at some point), we point you towards those utilities that have an element of growth, so they can not only grow earnings – but grow their dividend payments as well, giving you a positive return in real terms.
Again, this means steering clear of “vanilla” utilities, like Consolidated Edison who simply distribute energy to their regions at specified rates, while seeking out those companies that have an area of earnings growth beyond rising electricity rates. One prime example is FPL Group (a member of both our Growth and Income Portfolios), which has seen its unregulated energy generation business, NextEra, become an increasingly large part of its overall operations. In addition to a stable utility business in Florida, FPL has become the largest wind energy producer in the country. The NextEra business unit now accounts for roughly 70 percent of FPL’s $16.4 billion in annual profits and has the company’s earnings growing at a double digit rate. This part of the business stands to further its gains as we continue to see conventional fuel prices rise, and alternative (and renewable) energy forms see increased demand.
The shift to renewables is also being stressed by the Obama Administration with their proposed “cap-and-trade” system. The plan calls for federal mandated limits on the amount of greenhouse gases companies can emit, in an effort to combat global warming. A bill currently in Congress aims to reduce America’s industrial carbon dioxide emissions by about 70 percent by 2050.
Under the cap-and-trade program, companies that produce less than the mandated amount can sell their right to pollute to others. There’s a lot of work still to be done on the plan, but consumers are likely to end up paying higher electric bills no matter what. The plan would be a boon for utilities, like FPL Group, that produce electricity using alternative power. In addition to its wind generation, FPL also boasts nuclear exposure whose emissions would similarly fall below the mandated limits. The plan would also hurt some of FPL’s competitors that rely heavily on coal or natural gas to run their power plants. Alternative power generation is largely unregulated and already carries higher profit margins; the carbon credits would further pad FPL’s coffers, allowing them to expand operations further.
The company is the poster child for having the best of both worlds – double digits earnings growth with the cushion of a stable utility business – and should be a sizeable position in both growth and income oriented portfolios alike. Shares have already performed well this year, but still only sit at 13 times next year’s earnings, and yield 3.3 percent. With growth in the double digits, shares remain attractive on a PEG basis.
