Wednesday - November 2, 2005

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Our senior utilities analyst, Jon Kolb, sat down with us recently to give his perspective on various aspects of the utilities industry, from affects of the recent hurricanes to an expected rise in this winter's heating rates.

Jon, what do you consider the single biggest issue affecting utility companies right now?

Well, as you probably know, earnings for utility companies are regulated to give company profits and a reasonable return to shareholders. Utilities can earn up to an authorized ROE (return on equity) level, and most companies do come close to that. However, this also caps how much these companies can earn. And with, in 2002 or so, the average publicly traded utility having ditched the high-growth approaches of adding international assets or the disastrous energy trading schemes--a la Enron--earnings have by now settled down to reasonable, but not extraordinary, levels.

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Zacks Equity Research continued...

As we have seen over the past few weeks, across the board utility companies look the same--they’re all down. One of the main reasons for the recent sell-off, I feel, is interest-rate related. Any earnings growth we now see with utilities will either be partially or entirely offset by multiple contractions as interest rates continue to rise. We are likely to see one, two, maybe three more rate hikes, and we can also see that the entire yield curve--from the 90-day to the 30-year--is estimated at significantly above the average utility dividend yield. So we can see why bonds, for instance, are more attractive to investors at this point--they offer less risk and higher yield.

So what are some of the reasons you feel investors should still own utility stocks?

For one thing, M&A activity should continue, as the merger between Duke Energy (DUK) and Cinergy (CIN), as well as between Exelon (EXC) and Public Service Enterprise Group (PEG) have proven successful. The repeal of the Energy Policy Act has opened the door for extensive M&A activity, so we do expect additional consolidation in the sector motivated by domestic distressed assets, European privatizations, assets in favorable regulatory environments, and national and/or global powerhouses with rich valuations targeting regional generators for growth. Potential acquirers may include Dominion (D), DTE Energy (DTE), Duke (DUK), Entergy (ETR), Exelon (EXC), Florida Power & Light (FPL), and Southern Company (SO). Attractive targets may include Calpine (CPN), Dynegy (DYN), El Paso (EP), First Energy (FE), Aquila (ILA) and Williams (WMB).

Overall, utilities are doing well. Most are earning above the weighted average cost of capital, have cash flow to cover their dividends, and are able to put in additional capital expenditures to help grow their businesses. They are also paying out less in dividend yields so that they can put money back into new plants and subsidiaries, which is theoretically a very sound corporate finance strategy. Over the long-term, this expansion and development among utilities should prove more advantageous to shareholders, though we're not talking about a super-high growth industry that grabs a lot of newspaper headlines, such as biotech.

Also, keep in mind that government regulatory commissions will simply not let utilities fail. We saw this with the energy grid blackout in the Northeast during 2003, and in California the year before that. The entire system is designed for the utilities to generate profits and give a reasonable return to shareholders. It is a very stable regulated business with low risk, unless we happen to be talking about a special circumstance, like a bad hurricane or something.

Speaking of hurricanes, what was the impact of Hurricane Wilma on Florida, in your estimation?

It seems that Florida Power & Light (FPL) was hardest hit by the recent storms in Florida, at least of companies within my coverage. The company's earnings call for its third quarter is scheduled for the end of this week, so we should get a better indication of how bad the damage is at that time. And even though it doesn't seem to have done the damage that Hurricanes Katrina and Rita did in the Gulf Coast, Hurricane Wilma did have the lowest barometric pressure of any storm ever recorded, meaning it was one of the most powerful ever.

As far as what we know about Hurricanes Katrina and Rita, I did a lot of research as I was putting together my report on Entergy (ETP), one of the hardest hit corporate victims of the recent storm, not too long ago. The company’s smallest utility subsidiary, Entergy New Orleans, filed for bankruptcy due to Katrina-induced damage, and three of its other locations sustained significant damage to distribution and transmission facilities. Preliminary federal spending estimates placed the overall cost of reconstruction and recovery for Katrina at $150 to $200 billion, plus tens of billions of dollars more in insurance losses and billions more in asset replacement and lost business in the private sector. Projected Katrina-related costs therefore represent a greater than two-fold increase over the combined costs of the inflation-adjusted $43.7 billion in damage incurred by Hurricane Andrew in 1992. In short, it is likely to be recorded as the worst natural disaster in U.S. history.

Before I ask what we might expect from natural gas utilities over the coming winter, do you have any current Buy recommendations for us?

Yes, we are still bullish on TXU Corporation (TXU), as its earnings growth projections are still strong. Its stock price is still reasonable from a P/E perspective, and a recent increase in its dividend payout increases its attractiveness. The truth is, in the utilities industry, everything has come down in price so much that there is a lot of value to be found. But if we had to make one recommendation at this time, we'd say buy TXU.

OK, so tell us a bit about natural gas prices and how they will affect utilities.

Well, there's no doubt about it--this will be an expensive winter. Consumers can expect a 50% increase in home heating bills, and we do anticipate this will flow through to suppliers and shareholders. In short, we expect utilities will do very well. Most provide both electricity and gas, and there will be no getting around turning up the heat for most U.S. consumers--especially if this becomes a particularly cold winter.

One caveat I would offer, however, is that regulatory utility commissions operate state-by-state, and can become rather complicated to follow. Depending on how much profit is allowed based on these regulations will determine how strong the companies' performances will be, and these numbers will definitely vary. Also, if there are bad relations between a utility company and its state government regulator, this may result in further reduced commissions and profits for a particular company. So while this winter may be a great opportunity for utilities to bring in much greater revenues, it would be wrong to assume that every utility company will necessarily outperform the market.

Senior Analyst Jon Kolb covers investor-owned utility (IOU) stocks for Zacks Investment Research.

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MORE FROM ZACKS EQUITY RESEARCH...
 

BULL OF THE DAY

Diamond Offshore (DO) - Robust Drilling Demand. For full Zacks research report, click here.

 
BEAR OF THE DAY

MannKind Corp. (MNKD) - High Cash-Burn Rate. For full Zacks research report, click here.

 
ZACKS ANALYST INTERVIEW

Industry Rank for the Week of October 31

Banking stocks once again were beneficiaries of bullish analyst forecasts. More...

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Zacks.com offers three unique weekly commentaries that all further our mission to help you Profit from the Pros. Today is the latest installment of Screen of the Week from Kevin Matras. Each week, Kevin shares with you another winning screen he has discovered using the Research Wizard software from Zacks Investment Research. Learn more about the Research Wizard at: http://at.zacks.com/?id=2335.
 

“A Simple Dividend Strategy with Extraordinary Returns”

This week, I’m going to focus on a simple dividend strategy that has produced some amazing results over the last few years.

Since it’s a dividend paying strategy, I’ve incorporated a longer holding period (12 weeks and 24 weeks).

This strategy is both easy to build and easy to use with the Research Wizard.

The parameters to this screen are as follows:

• Price >= $10
• Market Cap >= $500 mil.
• Zacks Rank <= 3 (1, 2 or 3 -- no sell ratings allowed)
• Current Dividend Yield >= 8%

The Results:

I ran a series of tests using a 24-week holding period over the last 4-1/2 years. (Because a 24-week rebalancing period doesn't fit perfectly within a 52 week calendar year, each annual period was started at the beginning of the year and ended after two full 24-week holding periods (48 weeks) and annualized.)

In 2001, the annualized gross return was 31.7% while the S&P 500 was down -11.6%.

In 2002, the annualized gross return was 10.4% while the S&P 500’s was down -23%.

In 2003, the annualized gross return was a whopping 49.2% compared to the S&P’s 20.3%.

In 2004, the annualized gross return was 19.5% with the S&P up 9.8%.

And in the first half of 2005 (first completed 24-week period), the cumulative gross returns were 10.7% versus the S&P’s 1.2%.

(I also ran a series of tests rebalancing the portfolio every 12 weeks. These results also showed well, but of course, rebalancing more frequently would have cost more in commissions and the possibility of missed dividends.)

Either way, this Dividend Strategy has been a consistent performer through the ups and downs of the market over the last 4-1/2 years. (And hopefully in the years to come.)

Currently, there are 21 stocks that qualify this screen (for the week of 10/31/05). Here are some current names on that list:

To find out what other stocks qualify on this winning strategy, sign up for your free trial to the Research Wizard. Test this screen and others or build your own strategies and test them.

Remember the key to successful screening is in discovering those screens that have produced profitable results in the past. And that’s exactly what you get with the powerful Backtesting ability of Research Wizard. Click here to find out more about our free trial.

Discover all the Free Screening Tools on Zacks.com at: http://at.zacks.com/?id=2336.
 

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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The Zacks #1 Rank (Strong Buy) list is always limited to approximately 220 stocks. Four stocks that are currently included in this elite group are: ADTRAN, j2 Global Communications, JAKKS Pacific and SanDisk Corporation.
 

ADTRAN, Inc. (NASDAQ: ADTN) recently released third-quarter earnings of 64 cents per share, which topped analyst expectations by approximately 33% and improved on the year prior result. The company said its solid third quarter results demonstrate the successful execution of its strategies across both its consumer and business portfolios. Earnings estimates for the year ending December 2005 climbed 15 cents, or about 7%, over the past seven trading days. Continue your research on ADTN at: http://at.zacks.com/?id=2275.

j2 Global Communications, Inc. (NASDAQ: JCOM) announced fiscal second-quarter earnings of 43 cents per share, excluding items, in late August. The result outpaced last year’s 28 cents and eclipsed the consensus estimate by nearly 5%. The company stated that the positive trends experienced in the first quarter continued through the second quarter and enabled PVH to exceed its previous earnings guidance. Phillips-Van Heusen decided to raise its full year earnings guidance to a range of $1.75 to $1.80. Analysts are in agreement as evidenced by current estimates of $1.80 per share, which is about 3% higher than three months ago. Continue your research on JCOM at: http://at.zacks.com/?id=2276.

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Zacks Rank continued...

JAKKS Pacific, Inc. (NASDAQ: JAKK) recently reported third-quarter earnings, which equaled $1.05 per share. The result topped the consensus estimate by about 19% and outperformed last year’s earnings. The company noted that it expects to realize its previously issued earnings guidance for 2005 of approximately $2.28 per share. Analysts project similar results. JAKK has surpassed analyst expectations in four out of the last five quarters. Continue your research on JAKK at: http://at.zacks.com/?id=2277.

SanDisk Corporation (NASDAQ: SNDK) recently posted third-quarter earnings of 55 cents per share, jumping ahead of expectations by almost 53% and eclipsing last year’s 29 cents. The company commented that demand was strong throughout the quarter in its served markets. Earnings estimates for the year ending December 2005 climbed 32 cents, or about 20%, from one month ago. Continue your research on SNDK at: http://at.zacks.com/?id=2278.

To see the full list of Zacks #1 Rank stocks (approximately 220 stocks), go to http://at.zacks.com/?id=2279.

The Zacks Rank is a powerful stock indicator whose #1 Strong Buy stocks have risen by an average annual return of 33% since 1988 versus 11.8% for S&P 500.

To help you fully understand how the Zacks Rank works and, more importantly, how you can profit by using the Zacks Rank, we have created a free report - The Zacks Rank - Harnessing the Power of Earnings Estimate Revisions. This valuable information is available at: http://at.zacks.com/?id=2332.

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Here we cast the spotlight on a timely Featured Expert commentary that recently appeared on Zacks.com. Following the article you will find previews of other profitable commentaries with insights and recommendations from leading investment experts.

 
a) Donald Rowe, Editor of Wall Street Digest
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Most market analysts, including The Wall Street Digest, had high expectations for 2005. Going back through 90 years of stock market history, the fifth year of each decade has relentlessly produced the best gain of that decade for the stock market. The Dow Industrial Average posted the high for the year on March 4, 2005, at 10,936. Then, one surprise after another kept a lid on the stock market:

1) The damage from the tsunami in Asia was shocking. 2) The Greenspan Fed raised the Fed funds overnight interest rate every six weeks in 2005. The Fed funds rate has been raised from 1.0 percent in June 2004 to 3.75 percent in October, 2005, with expectations of at least one or two more quarter-point increases by January 2006. 3) The price of oil soared to a record high of over $70 a barrel during September. 4) Hurricanes Katrina and Rita damaged over 108 drilling platforms in the Gulf of Mexico, which virtually shutdown oil and gasoline production on the Gulf Coast. 5) Gasoline soared to over $3.00 a gallon in most of the 50 states. 6) An earthquake in Pakistan killed more than 50,000 people. 7) Delphi Corporation, a major manufacturer of automotive parts, declared bankruptcy and triggered speculation that GM would eventually declare bankruptcy, also. 8) Standard & Poor's downgraded GM's credit rating on $284 billion of debt. There is more, but you have the picture.

Despite all of these shocks to the economy and the stock market, the Dow Average has remained in a narrow 600-point trading range between Dow 10,100 and Dow 10,700 during most of 2005, even though stocks have remained 38 percent undervalued.

If stocks were at a market top, as numerous bears claim, these events of 2005 would have produced at least a mini-crash. But the performance of the economy and American corporations during 2005 has been truly impressive: Corporate earnings have set new record highs quarter after quarter during 2005.

State and federal tax receipts are still setting record highs month after month; and the economy continues to create new jobs and grow at a steady pace every month. A record 139 million Americans are working today. The net worth of Americans just posted another record high at $50 trillion-and $26 trillion––of that $50 trillion total is fairly liquid. American’s net worth was only $20 trillion at the beginning of the 1995-2000 bull market.

There is a record $5 trillion cash sitting on the sidelines in money market accounts, compared to $2.8 trillion in 1995. Corporations are sitting with a record $2 trillion in cash and cash equivalents. Corporations and corporate officers are using cash to buyback shares of their own company's stock because they believe the future value of these shares is far greater than cash-on-hand. Corporations are also using cash to purchase other companies. These are all signs that a great bull market lift-off is imminent!

 
A Sampling of Stocks to Watch

Ansoft Corporation (NASDAQ: ANST) is a developer of electronic design automation software used in high technology products and industries. Ansoft's software is used by electrical engineers in the design of state of the art technology products, such as cellular phones, internet networking, satellite communications systems, computer chips and circuit boards, and electronic sensors and motors. Engineers use their software to maximize product performance, eliminate physical prototypes, and to reduce time-to-market.

Blue Coat Systems, Inc. (NASDAQ: BCSI), formerly Cacheflow Inc, is a Web security company that delivers security appliances designed to combat the increasing number of Web-based threats targeting port 80 “holes” in the enterprise security infrastructure.

Concur Technologies, Inc. (NASDAQ: CNQR) focuses on reducing costly and inefficient expense processes in businesses of all sizes. From travel and entertainment expense management and travel booking, to the tracking of time, non-purchase order payment requests, and human resources self-service, the company allows businesses to better leverage their most limited resources: time, money, and energy.

TALX Corporation (NASDAQ: TALX) provides employee self-service solutions utilizing web, interactive voice response (IVR) and computer telephony integration (CTI) technologies to serve the human resources, employee benefits and payroll markets primarily for Fortune 500 and other large organizations. The Work Number is the market leader in automated employment verification and salary history to mortgage lenders and other verifiers.

Trident Microsystems, Inc. (NASDAQ: TRID) designs, develops and markets very large scale integrated circuit videographics and audio products for the desktop and portable personal computer market. The company's graphics, video and audio controllers typically are sold with software drivers, a BIOS and related system integration support.

 
About Donald Rowe’s Wall Street Digest newsletter

A SUPER ECONOMIC BOOM IS COMING! Momentum investor, Donald Rowe brings decades of experience and helps you utilize The Wall Street Profit System 2005™ to double your money every three years! http://at.zacks.com/?id=2328.
 

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MORE FEATURED EXPERTS...

b) Hammering Out a Bottom

Gregory Spear says it’s best to wait for the bottoming process to progress enough to reduce the risk of a much larger decline. More...
 

c) Bankruptcy Rumor Rattles World Markets

Richard Rhodes explains that a rumored bankruptcy filing has created confusion in the world capital markets. More...
 

d) What Will It Take?

Ron Rowland explains that there are two issues in the way of a rally. Learn about them and check out a mutual fund. More...
 

OTHER TOOLS FROM ZACKS

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At the heart of Zacks Investment Research is the Zacks Rank investment philosophy that continues to vastly outperform the market. Our Zacks #1 Ranked (Strong Buys) have produced the following results for investors:

• +33% average annual return since 1988 versus +11.8% for S&P 500
• Outperformed S&P 500 in 16 of the last 17 years
• +43.8% total return from 2000 to 2002, which was the worst bear market in over 60 years.
• +18% in 2005 (through September 30)

And just as importantly, the Zacks #5 Rank (Strong Sell) List has alerted investors as to which stocks to dump from their portfolios to avoid unnecessary losses.

To truly take advantage of the Zacks Rank, you need to first understand how it works. That's why we created the free special report: "Zacks Rank Guide: Harnessing the Power of Earnings Estimate Revisions". Download a free copy now to prosper in the years to come, by visiting: http://at.zacks.com/?id=2332.

Or view the full list of Zacks #1 Ranked stocks at: http://at.zacks.com/?id=2279.

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We hope you enjoyed this issue of "Profit from the Pros", And we look forward to visiting with you again next week.

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Senior Market Analyst
Zacks.com

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The Zacks Performance Rank performance is the total return of equal weighted simulated portfolios consisting of those stocks with the indicated Zacks Rank net of fees. Results reflect the reinvestment of dividends and other earnings. Simulated results do not represent actual trading and may not reflect the impact that economic and market factors might have had on decision-making if an adviser were actually managing a client's money.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor's. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index.

Disclaimer: Past performance does not guarantee future results. Investors should always research companies and securities before making any investments. Nothing herein should be construed as an offer or solicitation to buy or sell any security.

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