Stock Stars

 

IN THE REBOUNDING STOCK MARKET of 2010, the energy sector couldn't keep pace with the 11 percent rise in the Dow Jones Industrial Average. Depending on your yardstick, the Dow Jones Utility Index rose 1 percent and the Morningstar Utility Index increased 7 percent, so utility stocks underperformed the market as a whole. Yet certain regional, mid-cap energy stocks shined.

SNL Energy, a financial research firm based in Charlottesville, Va., analyzed the market and identified the top 10 energy stocks of 2010 on the basis of stock price, not including dividend yield.

SOUTH JERSEY INDUSTRIES was a top performer with a stock jump of 38 percent, heading an elite grouping that posted dramatic stock gains.

What triggered the spike in the top utility stocks while so many others rose only slightly or were flat?

Many diversified large-cap utility stocks were sluggish in 2010 due to falling market prices, explained Travis Miller, associate director for utility research at Morningstar, based in Chicago. Utility stocks rose in the first three quarters of 2010, but when the economy rebounded and interest rates rose, utility stocks lagged the market.

Most top-10 mid-cap energy stocks fall under the radar screen of most analysts, noted Daniel Fidell, a senior utility analyst with the investment banking boutique Brean Murray Carret & Co. For example, South Jersey Industries has a market value of $1.5 billion, Northeast Utilities $4 billion and National Fuel Gas about $5 billion, a fraction of Duke Energy, AEP and Southern Company.

Nonetheless, the top-10 mid-cap energy stocks had "the optimal model for the current environment, supportive regulators helping to recover costs for volatility in earnings, and a forward focus on infrastructure development including replacing aging transmission and expanding gas pipeline and storage development," Fidell said. These activities often yield 12 to 15 percent return compared with about 9 or 10 percent for utility distribution companies.

South Jersey Industries is a diversified holding company that distributes gas to 335,663 residential and commercial customers in Atlantic City and southern New Jersey. Its subsidiaries, such as South Jersey Energy Solutions and SJ Resources, offer solar arrays as well as combined heat and power and landfill gas to electricity projects.

In a December retail report, Value Line's energy analyst Michael Napoli attributed South Jersey's solid performance to several factors: maintaining its thriving retail energy business, gaining new customers who switched to cheaper natural gas over home heating oil, and increasing its dividend 11 percent in 2010 to 36.5 cents a share, which rallied investors.

South Jersey Industries CEO Edward Graham, who is based in Folsom, N.J., pointed to its diversified portfolio: 45 percent of its earnings stem from nonutility subsidiaries selling gas and electric and solar rays, and 55 percent stems from regulated gas customers. Its non-utility businesses grew 20 percent in 2010 while the regulated gas business increased 5 percent. Other factors included a September rate increase that added $10.9 million to earnings and its investment in Marcellus Shale in western Pennsylvania. In fact, its earnings increased 16 percent on average over the last five years, so it wasn't a one-year wonder but had sustained growth.

Diversification drives South Jersey Industries. Its multiple revenue streams include "making money from production, getting paid as a marketer, owning interstate pipelines," Graham said.

One analyst, whose company does not permit him to be quoted, said, "Though South Jersey is a well-run and stable company, you can't bank on steady growth. Its earnings didn't increase 40 percent," he said, so don't expect that 38 percent return this year. Graham counters that its regulated gas industry should grow more than 5 percent in 2011, Marcellus shale investments will continue to pay off, and other projects are in the works.

EL PASO ELECTRIC is a vertically integrated electric utility with 370,000 retail customers in western Texas and southern New Mexico. Its CFO, David Carpenter, says its stock spiked due to a growing customer base driven by the rapidly expanding Fort Bliss Army base. The base grew from 9,000 troops in 2005 to 24,000 troops in 2010 and is on target for 33,000 soldiers by 2012. Moreover, El Paso received two rate hikes, a $5.5 million hike in 2009 in New Mexico and a $17.2 million hike in Texas in 2010. In the fourth quarter, its announcement that it was exploring issuing its first dividend also sparked the stock price.

This year, Carpenter expects steady growth but downplayed expectations, noting that a repeat of its 36 percent spike from 2010 was unlikely.

NATIONAL FUEL GAS is a diversified natural gas and pipeline utility that serves 730,000 customers in Buffalo, N.Y., and Erie and Sharon, Pa. But treasurer and principal financial officer David Bauer, who is based in Williamsville, N.Y., noted that its stock rose not from its stable regulated business but from natural gas exploration and production. Key to the growth was its drilling in the Marcellus Shale in western Pennsylvania, which yielded 428 billion cubic feet of natural gas in 2010, an increase from 249 billion cubic feet the previous year.

National Fuel owns 740,000 acres of Marcellus Shale and has only begun to take advantage of the vast natural gas reserves there. It drills in 65 wells and is expected to add 100 to 130 wells in 2011. Because of that added capacity, Bauer sees no reason the company can't continue its growth.

Tim Winter, a utility analyst with Gabelli Funds, reinforced Bauer's view, saying that the company's stock rise was attributable to "growing market recognition of its undervalued and significant natural gas reserve positions" associated with a roughly 800,000 acre ownership position in the Marcellus Shale, including 745,000 acres in the Pennsylvania fairway. He also noted steady income from its mature regulated gas and pipeline and storage business.

What will 2011 bring for utility stocks? Morning-star's Miller isn't bullish on the energy sector because he sees weak or volatile commodity pricing slowing earnings for many utilities. Based on the performance of the top 10 stocks in 2010, small and mid-cap utilities that drill in the Marcellus Shale for natural gas and have diversified businesses that look promising.

 

BY PRICE CHANGE (%) IN 2010

	UTILITY TYPE	PRICE CHANGE
South Jersey Industries	Gas	38.34
El Paso Electric	Electric	35.75
National Fuel Gas	Gas	31.24
UGI	Diversified	30.55
Chesapeake Utilities	Diversified	29.55
Southwest Gas	Gas	28.53
ONEOK	Gas	24.46
Northeast Utilities	Diversified	23.61
OGE Energy	Diversified	23.45
Corning Natural Gas	Gas	22.86