With the Fed’s continued buying up and pushing down yields in bonds, investors have been frantic to find yield in the more risky equity market. The stocks that have seen the best run ups are in the utility sector. Old guard companies that turn out a consistent profit, but have limited growth potential were among the favorites. In this
century, we all continue to need the products and services that water, electric, and telephone companies provide.
Water
Aqua America Inc (NYSE:WTR) is a growing water utility in the U.S. whose stock has risen 27% year to date, and it services 3.1 million residents, has a market cap of $4.6 billion, and ambitions to grow. Aqua America has some exposure to hydraulic fracking, by supplying drilling companies with water, but it receives over 90% of its revenue from supplying residents with water.
The water industry is the most fragmented of the major utilities. Aqua America Inc (NYSE:WTR) estimates that there are nearly 50,000 entities that control the water supply in this country. Most of these are comprised of individual townships that supply water locally, and these could be great takeover targets for Aqua America. Last year, Aqua America completed four bolt on acquisitions, and as Aqua America gets larger, it would gain more leverage negotiating prices for things like pipes and filters from its suppliers.
Aqua America Inc (NYSE:WTR) is sitting on solid ground financially. The company has operating margins of over 42% and has a virtual monopoly in the markets that it services. Aqua America only pays out 48% of earnings to support a dividend yield of 2.30%, but it is using the rest of its earnings for capital projects that will generate more earnings in the future. As Aqua America expands its footprint, it will better be able to allocate capital upgrading and laying new pipelines. Aqua America will see both its revenue and earnings expand as it increases it service territories, and cuts expenses.
Communication companies
With the monopoly era of land-lines taking its final breaths, telecommunications companies have shifted to providing broadband internet and competing in the wireless market. AT&T Inc. (NYSE:T) is the biggest U.S.-based phone company with a market cap of nearly $200 billion and competes as an oligopoly or monopoly in most of its markets.
AT&T has not only been able to dominate in the telecommunications space for decades, but it also evolved as the number two provider of cell phone service behind Verizon Wireless, and is a heavy competitor in the ISP space. As the telecom industry consolidated, AT&T Inc. (NYSE:T) was able to retain healthy operating margins of 10.1% and pays out nearly 55% of its free cash flow to support its 4.90% dividend.
AT&T’s exceptionally high dividend and stable business model has given it a unique opportunity in this low interest rate environment. AT&T Inc. (NYSE:T) was able to borrow funds at an interest rate of 2% to repurchase stock. By repurchasing shares at an interest rate lower than its dividend, AT&T’s 2012 stock repurchases effectively saves it $770 million per year in dividend payments. In addition to the interest expense on these bonds being so low, it is also tax deductible. Ma Bell is looking like a great alternative to bonds.
Electricity
Duke Energy Corp (NYSE:DUK) is the largest publicly traded utility in the U.S. with over 7.1 million customers served across the Eastern half. Duke has its fingers in all facets of the energy industry from generation to distribution. The electric industry is also seeing consolidation like Duke’s merger with Progress Energy that closed this year. As these companies expand, they are able to reduce duplicate processes like billing or HR departments. Duke stated on its last earnings call that the synergies from this merger are already accretive to earnings, and will be higher than then anticipated.
The electric industry does have one threat that could turn into an opportunity if electric utility companies play their cards right: cheap solar power. As per watt costs come down on solar panels, companies like SolarCity Corp (NASDAQ:SCTY) are making their systems available to more people. A person with a home in a state that has a lot of sun exposure can purchase solar power directly from the panels installed on their roof while reducing the bill they pay the utility company.
This could potentially become a revenue problem. However, on the expense side of the equation, this could be a blessing in disguise. Electric utilities have to be able to handle peak demand for electricity, and that typically happens on the sunniest of days. Those same days would be generating the most electricity from solar panel installations. If there are enough solar panels, a utility could potentially allow a power plant to retire without replacing it. Plus, its customers will still be paying electric distribution costs to be plugged into the grid for consistent electricity.
Duke has an operating margin of nearly 18% and sports a dividend of 4.30%. We can expect Duke to increase its dividend at a slow but steady rate going forward as it realizes synergies from its recent merger.
Foolish bottom line
All three of these stocks operate in industries that require massive amounts of capital to enter, and this gives each of these stocks some security. Conservative investors would do well investing in AT&T Inc. (NYSE:T) or Duke Energy Corp (NYSE:DUK) for their out sized yields. Investors that have a longer time horizon and don’t necessarily need dividend income today should invest in Aqua America Inc (NYSE:WTR) to see capital gains as well as dividend increases as this company expands.
Wes Patoka owns shares of AT&T, Duke, and Aqua America. The Motley Fool recommends Aqua America.
The article Where Can an Investor Find Yield Today? originally appeared on Fool.com.
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