Monday - April 17, 2006

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After a strong run in utilities stocks over the past few years, it looks as if the industry is starting to experience a bit of a pullback. How are utilities adjusting, and what areas of growth are out there for investors to take advantage of? We spent some time with senior utilities analyst Jon Kolb to discuss these matters.

The last time we spoke, consolidation was the main issue among utilities. Has anything changed?

I would say consolidation is still the main story. Our outlook for utilities, or utes, is market-neutral in aggregate, over the near term. The impetus for this is we’re at or near the peak in the Fed funds cycle. Many expect, including myself, that we may see one or two more quarter-percent hikes, but that’d be it.

Utes have had a great multi-year run, with very strong performances overall. But now, as rates get past four, four and a half percent – where the average dividend yield for utes has been, depending on which part of the utes sector you’re looking at – investing in utilities is becoming less attractive than the risk-free investments which offer the same four-plus percent rate the utes typically do. Now, there are some utes with more attractive yields – five, even six percent, in some cases – these are not risk-adjusted returns. And unless these companies can generate significant earnings growth through 2006, 2007, those yields are simply not sustainable. Over the long-term, no company can afford to pay out more in dividends than it makes in earnings.

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Zacks Equity Research continued...

Which brings me back to consolidation as the main growth driver in the utes sector over the near term. This is the main way utes are going to continue growing at anywhere near the percentages they had been over this multi-year run-up.

Are you seeing a lot of consolidation planned for the near future?

A lot. This is definitely continuing in a big way. What we’d recommend for investors is to, in the near term, look at regional plays in attractive regulatory environments – the Northeast, the Southwest – with solid and growing customer bases, particularly where other utes have been taken over. That’s where investors can see a pop in the stock price, as there should be a premium for any such deals as these. This is our short-term recommendation for investors.

For the longer term, we’d suggest going with regional dominant players – Duke Energy (DUK), Exelon (EXC), Southern Companies (SO), maybe even Edison International (EIX) – as part of a multi-year Buy and Hold strategy. Once a deal is announced, usually the acquirer goes down in stock price as the acquired company goes up. This often marks a good time for investors to buy in to the acquirer; it’s often a good entry point for the large-cap utes over the long term. Obviously, it’s even better if the investor has already bought some of the smaller utes getting acquired.

Are there still many small-cap utilities ripe to be taken over?

Plenty. Of course, with each deal the number ticks down a notch, but there are still lots of good buy-out candidates out there. These are not only attractive to U.S. players, but to large European companies, as well. We have been seeing more of European companies coming into the U.S. market, like when National Grid (NGG) bought KeySpan several weeks back. It doesn’t really make a difference whether a company is acquired from a domestic ute or a foreign one; the main thing for investors is if they’re going to see a premium in the deal and get a pop in the stock. This is going to attract investors in the near term far more than real earnings growth from any individual story.

But we’re pretty much at a rates peak now, do you think?

Whatever the consensus is on Wall Street, pretty much. Rates are generally kept fairly well in-line with what’s going on in the broader economy. The thing is, there needs to be something that causes the Fed to stop raising rates.

Over the very long term, say the next 20 years or so – around the globe, for all utilities – there will need to be a lot of investment in being able to supply the market with electricity, as electric demand will keep growing. For utes, this means earnings should grow apace with that demand, generally speaking. This country will need billions invested in upgrading the electrical grid and the whole utility infrastructure. Same goes for natural gas, with their pipelines and such. And how quickly and efficiently this happens depends on the regulators, and they are a tough bunch to read.

Are rates determined mostly on a state-by-state basis?

The Federal Energy Regulation Commission (FERC) regulates on a federal level, of course, but each state has its own commission, too. So yes, basically these are determined on a state-by-state basis. Some states are more regulated than others. Some are completed deregulated, such as – broadly speaking – regions in the Northeast and Southwest. From the Northwest down to Florida, including most of the heartland, these states are more regulated; they keep closer tabs on the rates utilities can charge.

Read the complete Analyst Interview by clicking: http://at.zacks.com/?id=2723

Jon Kolb is a senior analyst covering the utilities sector for Zacks Equity Research.

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MORE FROM ZACKS EQUITY RESEARCH…

Analyst Blog - NEW!

Get real-time market insights from Zacks Equity Research Analysts. To see their latest posts, click here.

 
BULL OF THE DAY

Sycamore Networks (SCMR) - Growth Through Acquisitions. For full Zacks research report, click here.

 
BEAR OF THE DAY

CONMED Corp. (CNMD) - Losing Market Share. For full Zacks research report, click here.

 
ZACKS INDUSTRY OUTLOOK

Spending Growth Helping Business Services

Outsourcing to experience strong growth over the next three-to-five years. More...

 
EARNINGS TRENDS

S&P Earnings Season off to Strong Start

Director of Research Dirk Van Dijk said the first quarter is off to a spectacular start, but the pace may not be sustainable. More...

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Zacks.com is proud to share with you some of the best trading strategies that truly allow you to Profit from the Pros. Today we highlight...
 

Profit Tracks: High Rank Value

Two of the most commonly accepted measures of a value stock are a price-to-earnings (P/E) multiple of 15.0 and a price-to- book (P/B) multiple of 3.0. Although many studies have shown performance advantages to investing in value stocks, not all value stocks are actually bargains. A value stock is only a good buy if earnings are expected to improve in the future.

High Rank Value is a strategy designed to find the true bargains among value stocks. By requiring a Zacks Rank of #1 ("Strong Buy") or #2 ("Buy"), this strategy restricts the pool of value stocks to only those with positive revisions in earnings estimates. In other words, profits are expected to improve in the future at a faster pace than originally anticipated.

The combination of a low valuation and a high Zacks Rank is very profitable. This Profit Track has consistently topped the S&P 500 during the past five years. In 2005, this strategy generated a return of +13.7%.

 
Here are four stocks that make the grade for the High Rank Value Profit Track:

American Electric Power Co., Inc. (AEP) reaffirmed its 2006 full year earnings guidance of $2.50 to $2.70 per share in early March. Analysts are in agreement as evidenced by current estimates of $2.61 per share, up from three months-ago levels of $2.60. In early February, the company reported ongoing earnings for the fourth quarter of 29 cents per share, beating the consensus estimate by almost 12%. The public utility holding company has a price-to-earnings (P/E) multiple of 12.35 and price-to-book (P/B) multiple of 1.46. Continue your research on AEP at: http://at.zacks.com/?id=2254.

Energy East Corp. (EAS)offers a price-to-earnings (P/E) multiple of 13.34 and a price-to-book (P/B) multiple of 1.26. The company released unaudited fourth-quarter earnings of 43 cents per share in early February, exceeding the year-prior result. EAS noted that earnings were ahead of last year primarily due to higher margins on electric sales and an increase in electric deliveries. Continue your research on EAS at: http://at.zacks.com/?id=2255.

iStar Financial Inc. (SFI) reported fourth-quarter earnings of 81 cents per share in late February, matching the consensus estimate. The company mentioned that Last year it achieved a number of significant milestones that helped it compete during a challenging year and position it well for the long-term. SFI’s shares offer a price-to-earnings (P/E) multiple of 11.27 and a price-to-book (P/B) multiple of 1.75. Results for the first quarter will be available on April 25. Continue your research on SFI at: http://at.zacks.com/?id=2256.

First United Corporation (FUNC) satisfies the criteria for this Profit Track with a price-to-earnings (P/E) multiple of 11.41 and price-to-book (P/B) multiple of 1.53. The company, a Zacks #1 Rank (Strong Buy) name, is a one-bank holding company with two non-bank subsidiaries. In late February, the company posted fourth-quarter earnings of 69 cents per share, which was ahead of the year-prior performance. Continue your research on FUNC at: http://at.zacks.com/?id=2257.

To see the full list of stocks that currently pass this winning screen, go to: http://at.zacks.com/?id=2258.

All the Profit Track strategies were created and backtested using the Research Wizard software from Zacks Investment Research. If you like this screening strategy, but want to narrow down the list of stocks and even improve the performance, then you should start a free trial to this powerful stock picking tool. Learn more about the Research Wizard free trial offer and our new special report “Top 10 Stock Screening Strategies” at: http://at.zacks.com/?id=2307

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SCREEN OF THE WEEK

Great Stocks often have Great Peers

Kevin Matras looks at how to find winning stocks in the winningest Sectors: http://at.zacks.com/?id=2259.
 

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Every day on Zacks.com we highlight four Zacks Rank Buy stocks. Each individual stock is chosen based on how well they match the criteria for the four main schools of investing: Aggressive Growth, Momentum, Growth & Income and Value.
 

Aggressive Growth – Digene Corporation (DIGE)

Digene Corporation (DIGE) has met or exceeded earnings estimates in five out of the past six quarters, with the last two surprises averaging over 100%. Seven different analysts raised their numbers for this year. Over the past 60 days, estimates for fiscal 2006 have increased 8.3% to 65 cents per share. Despite the strong year-to-date gain of 31%, the stock is still attractively valued. Read the full analysis on DIGE at: http://at.zacks.com/?id=2510.
 

Growth & Income – The Boeing Company (BA)

The Boeing Company (BA) upped its 2006 earnings guidance in early February after releasing solid results for 2005. The company has topped analysts’ expectations in 11 of the past 12 quarters. Earnings per share are forecasted to grow 13.6% over the next 3-5 years. BA has a current dividend yield of 1.5% and a five-year average dividend yield of 1.7%. Read the full analysis on BA at: http://at.zacks.com/?id=2511.

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Zacks Rank continued...

Momentum – Energy Transfer Partners LP (ETP)

With Monday’s breakout of an eight-month trading range, clearly things are changing for Energy Transfer Partners LP (ETP). For more than eight months, ETP had been locked in a $39 - $32 trading range, with the exception of a failed two day breakdown back in Oct. ETP began nibbling at the top in of the range as early as Mch 20 on light volume. Nothing to get excited about. However, with the release of Monday’s earnings report, ETP has decisively broken out into new high ground confirmed with volume more than twice the two month average. Read the full analysis on ETP at: http://at.zacks.com/?id=2512.
 

Value – Lone Star Technologies, Inc. (LSS)

Lone Star Technologies, Inc. (LSS), a Zacks #1 Rank stock, has topped earnings estimates in seven of the past eight quarters. The company reported record 2005 profits in late January. LSS has a price-to-book (P/B) multiple of 2.8 and an impressive return on equity of 39%. Read the full analysis on LSS at: http://at.zacks.com/?id=2513.
 

Zacks Rank Resources

• View All Zacks #1 Rank stocks: Go to: http://at.zacks.com/?id=2266.
   
• Free Zacks Rank Guide: Learn how to use the Zacks Rank to pick more profitable stocks. Get the guide: http://at.zacks.com/?id=2267.
   
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• Zacks Options Trader: Combine the timeliness of Zacks #1 Rank stocks with the explosive profit potential of options. Learn more at: http://at.zacks.com/?id=2700.
   
• Zacks Wealth Management: Own all the Zacks #1 Ranked stocks in a portfolio managed by Zacks. Learn more at: http://at.zacks.com/?id=2539.

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Here we cast the spotlight on a timely Featured Expert commentary that recently appeared on Zacks.com.

 
Donald Rowe, Editor of the Wall Street Digest

Historically, the first two weeks of April tend to be weak ones for the market. However, with growing optimism over strong first quarter earnings, Donald Rowe and his team expect a substantial move-up in stock prices between mid-April and August.

Liquidity is at record levels and the stock market is still undervalued by 30 percent. Cash corporate buybacks and merger and acquisition activity continues, shrinking the number of shares available for purchase. In addition, the M3 money supply, at more than $10 trillion, is at a record high. All of this is bullish and points to higher stock prices ahead.

For now, Rowe and his team continue to focus their recommendations in the technology sector, and the small- and mid-cap stocks and indices.

 
A Sampling of Buy Recommendations:

Joy Global, Inc. (JOYG) is a worldwide leader in manufacturing, servicing and distributing equipment for surface mining through its P&H Mining Equipment division and underground mining through its Joy Mining Machinery division.

Lawson Software, Inc. (LWSN) is a leading provider of enterprise software solutions targeting specific services industries. They offer comprehensive financial management, human resources, professional services automation, procurement, distribution and customer relationship management solutions designed to manage, analyze and improve their customers’ businesses. Their software solutions automate and integrate critical business processes, facilitating collaboration among customers, partners, suppliers and employees.

NetLogic Microsystems, Inc. (NETL) is a semiconductor company that designs, develops and markets high performance knowledge-based processors for a variety of advanced Internet, corporate and other networking systems, such as routers, switches, network access equipment and networked storage devices. NetLogic Microsystems' knowledge-based processors employ an advanced processor architecture and a large knowledge database containing network and network user information to make complex decisions about individual packets of information traveling through the network.

On Assignment, Inc. (ASGN), through its first operating division, Lab Support, is a leading nationwide provider of temporary scientific professionals to laboratories in the biotechnology, pharmaceutical, food and beverage, chemical, and environmental industries. The company's strategy is to serve the needs of targeted industries for quality assignments of temporary professionals.

Red Hat, Inc. (RHAT) is a leading developer and provider of open source software and services, including the Red Hat Linux operating system. Unlike proprietary software, open source software has publicly available source code and can be copied, modified and distributed with minimal restrictions. The web site, REDHAT.COM, is a leading online source of information and news about open source software and one of the largest online communities of open source software users and developers.

 
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.

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:

• +32.5% average annual return since 1988 versus +11.8% for S&P 500
• Outperformed S&P 500 in 17 of the last 18 years
• +43.8% total return from 2000 to 2002 - the worst bear market in over 60 years.
• +18% in 2005

And just as importantly, the Zacks #5 Rank stocks (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=2309.

Or view the full list of Zacks #1 Ranked stocks at: http://at.zacks.com/?id=2266.

FREE PORTFOLIO TRACKER

Do you believe that these events affect stock prices?

• Broker Recommendation changes
• Earning Estimate revisions
• Earnings Announcements
• Zacks Rank changes

If you answered yes, then how are you staying on top of these changes for your stocks? If you are one of the 45,000 investors who wake up every morning to the Daily Portfolio Updates emails from Zacks.com, then you are all set. If not, then sign up now to get this vital information sent to you daily and improve your portfolio's performance. Did we mention it's free? Get started now by going to: http://at.zacks.com/?id=2310

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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Regards and Happy Investing,

Charles Rotblut, CFA

Senior Market Analyst
Zacks.com

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*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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