Utility stocks make up one of those market sectors known for slow, steady returns and high dividends that many income-seeking investors desire. Very rarely do they ever go on sale as a result, and it's hard to find value stocks in the segment. As with everything Wall Street, though, there are occasions when some valuations get a little out of whack, allowing these stocks to be bought at a discount.
So we asked three of our contributing investors to each highlight a value stock in the utility sector today. Here's why they picked Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS), Eversource Energy (NYSE: ES), and SCANA Corporation (NYSE: SCG).
Still priced for previous troubles
Tyler Crowe (Companhia de Saneamento Basico do Estado de Sao Paulo): Brazilian water utility company Companhia de Saneamento Basico do Estado de Sao Paulo -- Sabesp for short -- went through an incredibly tough stretch a couple of years ago, as it dealt with one of the worst droughts the state of Sao Paulo had seen in decades, as well as the declining value of the Brazilian real.
The drought meant the company was forced to offer incentives to customers for reduced water usage. This low-revenue period couldn't have come at a worse time for a company that was investing heavily in ensuring 100% connection rates for water and sewer for Sao Paulo residents. As a result, the company's stock took a pounding from 2013 to 2016.
Many of the issues that plagued Sabesp have gone away for now. Rains have mostly replenished the company's reservoirs, and management is working on projects that will increase inflow to its reservoir systems by 13%. Sabesp has also been reducing its exposure to foreign currency fluctuations by paying off some of its foreign currency-denominated debts. Both of these initiatives will significantly reduce the company's future risks and make it the kind of boring, stable water company that most investors want when investing in utilities.
But even though management has made these changes, Wall Street still seems skeptical of this stock as it trades for an enterprise value-to-EBITDA ratio of just 6.4. American water utilities trade at valuations almost double that amount.
Sabesp is a slightly more risky stock than other water utilities because it still has some foreign currency risk, but it still operates in a lower-risk, regulated business. Based on its current price, it looks like quite the value.
A decent dividend and a reasonable valuation
Tim Green (Eversource Energy): Finding value in utility stocks isn't easy these days. But Eversource Energy, a utility that operates in Connecticut, Massachusetts, and New Hampshire, looks like a better value than most of its peers. While the stock is nowhere nearly as cheap as it was five years ago, it's still a reasonable choice in the utility sector.
Eversource stock has surged this year, up about 11% year to date, but its valuation is still not all that stretched. The stock's price-to-earnings ratio, based on trailing-12-month numbers, is just shy of 20. That's far from no-brainer bargain territory, but it's well below the P/E ratio of the S&P 500, which hovers right around 25. Eversource's price-to-book value ratio also isn't all that high, sitting at roughly 1.8.
Eversource doesn't have the most generous dividend in the world, with the current yield just above 3%. But that dividend is well covered by earnings, with the payout accounting for about 60% of earnings over the past 12 months. This situation gives the dividend room to grow, and it gives the company some room for error. Eversource's per-share dividend has grown at a compound annual rate of 9.6% over the past decade, a solid track record.
If you're looking for a value utility stock to add to your portfolio, Eversource Energy is one to consider.
Cory Renauer (SCANA Corp.): While most U.S. utility stocks have surged this year, this company's role in an ill-fated attempt to build two big nuclear reactors has pushed the stock into deep value territory. Scana Corp. recently revealed that it had received a subpoena from federal prosecutors requesting a broad range of documents related to the project. The subpoena came about a month after the South Carolina governor's office released an audit from Bechtel that raised questions about how long Scana and its peers knew the project was unlikely to succeed.
South Carolina's Base Load Review Act cements Scana's right to recover prudently incurred nuclear development costs the company estimates at around $4.9 billion.
If you assume investigations can't prove the costs weren't prudent, and Scana can recover them, this stock might be the deepest value opportunity in the sector. Concern that the utility might not recover costs has driven the stock down to just 13.1 times trailing earnings.
Income investors would do especially well if the investigation proves fruitless. The stock offers a juicy 4.4% yield at recent prices and could go much higher. Management has stated a willingness to raise its payout ratio from around 55.4% at the moment to a maximum target of 65%.
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Cory Renauer has no position in any of the stocks mentioned. Timothy Green has no position in any of the stocks mentioned. Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.