Utility Stocks: Not as Safe as They Used to Be

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For a long time, electric utility companies had reputations for being boring yet safe stocks where even the most conservative investors could put their money. Volatility was usually low, and you could even find attractive dividend yields in the space.

Nowadays, a dollar invested in a utility stock is far from a sure bet. Looming government regulation is making utilities a dicier proposition for investors.

Beating estimates
Edison International (NYSE: EIX) is one good example. Last Friday, the company reported third-quarter profit that exceeded analysts' estimates, but earnings were still down more than 8% from the year before, as the company's merchant electrical generation unit suffered from weak demand.

Reported net income was $403 million, which came to $1.23 per share, but after adjusting for nonoperating regulatory items, core non-GAAP EPS came in at $1.09, a nickel higher than consensus estimates. Revenue took a 15% haircut, to $3.66 billion.

Taking a beating
More disturbing for shareholders, though, is a lawsuit that the Justice Department and the Illinois attorney general filed against Edison subsidiary Midwest Generation in August, complaining that six of the company's coal-fired plants violate the Clean Air Act. The plants, which were modified in the 1990s by their previous owner, Exelon (NYSE: EXC), may need to be retrofitted with expensive pollution-control equipment.

It's unclear what the ultimate cost will be. The company hasn't yet committed to a particular set of new equipment, in part because of uncertainties about what new environmental legislation will be put in place. The last thing any utility wants is to spend millions on equipment that may turn out not to meet future regulatory standards.

Just beat it
Interestingly, Edison's southern California subsidiary claims to use more renewable energy than any other domestic utility. Before you buy the stock, though, look for its Midwest unit to get these issues behind it and show tangible signs of improvement.

Increased regulation on the generation side of the business may make transmission companies more attractive. For instance, Boston-based NSTAR (NYSE: NST) and Connecticut-based Northeast Utilities (NYSE: NU) have already gotten the jump on bulking up their transmission systems.

Moreover, companies that export the world's most abundant fossil fuel to countries like China and India, where the governments aren't so hard on those who convert it into energy, may also be a better bet. Coal exporters like Peabody Energy (NYSE: BTU) may be of interest, and Walter Energy (NYSE: WLT), which focuses on metallurgical coal, looks like it could be a top growth stock.

As far as Edison is concerned, it looks like Uncle Sam and the state of Illinois could be major party poopers for a while.

Chris Jones loves fresh air, but he also cares about free and healthy energy markets. Where do you stand on punitive clean energy legislation? Share your opinions in the comments section below.