Dividend Edition: Utilities as an Income Investment

Utilities make great income investments. They generate reliable, fee-based income by supplying the public with essential services, and most are in markets with limited or no competition.

Utility companies are subject to regulation (with the amount varying by state) and most have to obtain permission to increase their rates, which can take quite a long time. But many utilities still manage to generate enough cash flow to reward their investors with quarterly dividends.

The latest Dividend Digest featured a bumper crop of utilities from a variety of sectors, including water and natural gas. It also included a recommendation for a utility ETF, a quick and easy way to get diversified exposure to utilities and their regular dividends.

One of the companies recommended in the Dividend Digest was Exelon (EXC), a diversified electric utility that generates energy using nuclear, hydro, solar, wind, landfill gas and fossil-fuel.

EXC was recommended by Chris Temple, editor of The National Investor. Here’s what he wrote about the stock in March:

“Exelon Corp.’s recent selloff has left us with a major utility—and one a whole lot larger now as it is about to close its deal to take over Constellation Energy—trading much closer to its 52-week low than is the case with most utilities, even after some of their own more modest recent corrections.

“Following the merger, Exelon—which will remain headquartered in Chicago—will reportedly have approximately 100,000 business and public sector customers and some 6.6 million residential ones. The company also has one of the country’s largest and cleanest power generation fleets, with about 35,000 megawatts of total owned power generation, including more than 19,000 megawatts of nuclear power.

“Indeed, we think that one unappreciated fact is that Exelon will benefit from a coming partial phase-out of coal-fired power. … Typically, Exelon has thrown off about $3 billion each year in free cash flow, more than enabling it to pay its hefty dividend and—at least before the 2008 financial panic—buy back its shares. For the moment, analysts will be watching to see how much of a hit bottom-line earnings take in light of the Constellation acquisition; forecasts expect a drop to around $3.00 per share this year and, at best, the same in 2013.”

Since that recommendation, EXC has given a few signs that Temple’s thesis could be correct. Looking at the chart, it’s possible that the stock completed a rounded bottom in April and is now ready to begin its recovery. And last week, EXC crossed back above its 50-day moving average on two days of higher-than-average volume.

Even with the slight uptick in price, EXC’s yield is still a solid 5.4%. Investors who buy now will lock in that yield for themselves, regardless of what the stock does next. EXC looks like a good choice here for investors willing to add a higher-risk utility to their portfolio.

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Investment of the Week

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