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Deregulation Shines No Light on Future of Utilities


The outlook for electric-utility stocks remains dim in light of the deregulation turmoil sweeping the industry.

State after state is trying to throw the government-regulated utilities open to competition, a trend that's supposed to benefit consumers but is leaving investors scratching their heads. California, which is being watched closely by the rest of the nation, partially deregulated its power companies March 31.

Because of the upheaval, the electric utilities were expected to quickly shed their longtime reputation as stocks for conservative, income-oriented investors (including widows and orphans).

For one thing, deregulation isn't an overnight process; it takes months and years not only to get approvals, but to see how the outcome affects competition. And the utilities themselves are debating where they want to play in the deregulated field. That leaves investors and Wall Street analysts struggling to estimate how much utilities will earn down the road.

Indeed, some utilities now are "seeking to shed commodity risk by selling off generation [assets] and focusing on distribution," noted analyst Kyle Rudden of J.P. Morgan Securities. "Others are opting for the higher-risk, higher-reward wholesale marketing/generation approach. Yet others are intent on becoming global."


With utilities now having to compete for a living, the companies' historically lofty dividends also were expected to become as old-fashioned as gas lamps--and quickly slashed.

But that hasn't happened. Certain utilities have cut their dividends deeply, but others have held them steady or even kicked them up a bit because they still have the financial strength to support their payouts, analysts say.

"There still will be some dividend cuts and less dividend growth than there used to be, but I don't see them [cuts] as a big flood, coming all at one time," said Kit Konolige, analyst at Morgan Stanley, Dean Witter Inc.

For now, then, electric companies continue to have high dividend yields that make them appealing to investors looking for steady income, analysts said.

The current average yield--calculated by dividing the annual per-share dividend by the stock's price--on the Dow Jones average of 15 utilities (which includes some natural-gas concerns) is 3.9%.

That's down from 4.5% a year ago, but mostly because the stocks' prices went up, not because dividends went down, said Dan Rudakas, analyst at Everen Securities Inc. in Chicago. The utilities' yield also remains well above the measly 1.4% yield on the benchmark Standard & Poor's 500 index.

Good thing, because the electrics' stock prices aren't lighting a fuse under investors. Their gains (if any) have generally lagged the broad market so far this year; the Philadelphia Stock Exchange's index of 20 utilities is up just 5%, less than half of the S&P 500's 14% advance.

Not everyone is bearish, however. With many investors jittery over the market's recent pullback and the impact of Asia's economic woes on U.S. stock prices, electric utilities still serve as a "defensive" sector of the market.


The stocks' "attractive" prices, combined with the companies' "stable fundamental outlook and defensive characteristics" will lead to better performance for electric utility stocks in the second half of the year, predicted analyst James Dobson of Donaldson, Lufkin & Jenrette Securities Corp. in New York.

But of course, Dobson states the obvious by noting that "selection is crucial in the sector."

Dobson's favorite investment idea is Public Service Enterprise Group Inc. (ticker symbol: PEG), which operates in New Jersey. The company is cutting costs, restructuring its debt, buying back stock, is modestly priced at $34.50 and sports an eye-grabbing 6.3% yield, he said.


"We calculate a fair value for the stock of $41 per share," Dobson said.

CMS Energy Corp. (CMS), which runs Consumers Energy in Michigan and has extensive international operations, is one of Konolige's top picks. He notes that CMS trades at less than 14 times his estimate of the company's 1999 per-share earnings and has "excellent prospects in most regions" of the world.

Also, CMS just hiked its dividend by 10%--to $1.32 a share per year from $1.20--effective in August, giving it a 3% yield at current prices. And with about 207,000 shares, CMS Chairman William McCormick Jr. "has one of the highest ownership levels among utility CEOs," Konolige said.

As for California providers, analysts tend to be neutral toward the group, in good part because the state's deregulation effort is just underway and the early results are mixed.

After a month of being able to buy power from any of the dozens of registered energy marketers, barely 1% of California's nearly 10 million eligible electricity customers had bothered to switch. One reason: Residential and small commercial customers got a 10% rate cut on Jan. 1, whether they switched or not.

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