3 Ways Utilities Can Deliver More Than Just Dividends

Utility stocks don't usually produce huge capital gains, but under certain circumstances, substantial returns can become more likely. Utilities PG&E, Northeast Utilities, and Sempra Energy have all delivered meaningful stock price gains to astute investors. Here's how they did it.

Feb 28, 2014 at 10:39AM

Utilities don't usually produce outsized share-price gains, but the sector can offer the occasional opportunity. Utilities coming back from a difficult circumstance, entering into a prudent merger, or diversifying wisely often deliver impressive returns. PG&E (NYSE:PCG), Northeast Utilities System (NYSE:ES), and Sempra Energy (NYSE:SRE) are some recent examples. How did they do it? Let's take a look.

Bouncing back from a disaster
Utilities coming back from an adverse event have often delivered notable share-price gains. PG&E is in the midst of such a recovery. Involved in the 2010 San Bruno, CA disaster, where a natural gas pipeline explosion killed eight people, the utility's stock price has bounced between a low near $40 and a high of about $48 since the mishap. The trend toward bearish levels is dependent on financial ramifications from the tragedy.

PG&E's costs related to San Bruno are going to be substantial. California regulators have found the company negligent and recommended a $2.3 billion fine be assessed. In addition, PG&E plans to expend at least $2.7 billion on improving its natural gas delivery system and legal expenses. The company spent around $652 million on such efforts last year alone.

Since regulators believe shareholders should bear the cost, PG&E investors are rightfully concerned. An extended payments timeline only increases the anxiety. It appears completion of disbursements could be a long way off. Only about half of the expected $2.7 billion in expenditures has been spent so far. Given the scale and scope of the tragedy, it isn't surprising that PG&E shares have slumped on any negative news related to the company's financial obligations. 

On the other hand, positive news about PG&E's operations seems to support the stock, and the energy provider has delivered some encouragement. Total company revenue climbed a solid 3.7% year over year in 2013 with further increases from rate hikes possible. The utility has requested approximately $1.2 billion in additional revenue for 2014, and $922 million over the following two years, in a recent rate-case submission. Though receiving the full amounts may be unlikely, any substantial increase would be a plus.

PG&E shares seem to be caught in a tug of war between worry and optimism, landing somewhere between $40 to $48 depending on current sentiment. The price range seems logical, however. The utility's fair business value looks to be around $44 per share based on current normalized cash earnings of around $1.8 billion at an industry standard 11 times multiple. Investors who have bravely purchased PG&E shares at a pessimistically induced discount have apparently profited nicely and may continue to do so.

Taking advantage of merger synergies
A prudent merger can also provide exceptional returns. Shares of Northeast Utilities have risen almost 25% over the last two years, mainly due to the utility's successful combination with competitor NSTAR. Expected to deliver significant benefits, the combined entity plans to make more efficient and cost-effective infrastructure investments while also achieving $780 million in savings over a 10-year period.

Northeast Utilities has seemingly delivered on those expectations, reporting an 11% year-over-year earnings per share gain and a 7% dividend increase in 2013. Beyond finances, the utility also registered record-breaking electric service system performance and completed key infrastructure projects on time and under budget.

The future appears as bright. Earnings per share are expected to gain another 6% in 2014, with planned long-term growth at 6% to 8%. Projected annual dividend increases of 6% to 8%, nearly twice the industry average, should also please shareholders. Operating under a rate freeze until 2015, a regulatory condition of the merger, this company guidance is very impressive.

Northeast Utilities investors have already benefited, but the stock may still be worth considering. Trading at a rich 14 times expected cash earnings of around $1 billion, the shares still might be viewed as reasonable given the company's expected growth trend.

Growth via wise diversification
Exceptional capital gains can also be derived from successful diversification. Sempra Energy shares have advanced around 60% over the last couple of years thanks to a well-planned expansion. Though receiving two-thirds of earnings from U.S.-based utilities, the company's growth vehicles are most exciting.

One growth avenue is potentially lucrative international opportunities. The company owns utilities in Peru, Chile, and Mexico that may offer better prospects than their domestic counterparts. Expansion into green energy also looks promising. Investing in smart-grid technology and a solar plant joint venture with utility peer Consolidated Edison, Sempra appears active in the burgeoning renewable-energy market.

Sempra's expansion in natural gas is most intriguing, however. The company recently received government approval to build a liquefied natural gas (LNG) processing and export plant off its running pipeline system. Sempra can now move forward on a plan to export up to 1.7 billion cubic feet of product per day, more than 14% of the government's total export allowance. This leadership position in LNG should reap future benefits as the industry develops.

Wall Street appears fully aware of Sempra's high-growth profile, however. Trading at a hefty 16 times its $1.4 billion in cash earnings, investors may find it prudent to wait for a pullback before considering a purchase.

Bottom line
Utility stocks are not typically thought to offer the potential for large capital gains, but there are occasions when they have the possibility. Whether coming back from an adverse event, merging wisely, or through successful diversification, utilities like PG&E, Northeast Utilities, and Sempra Energy have shown that meaningful share price appreciation is possible. Investors may want to watch for other such sector opportunities -- they might be equally profitable.

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Bob Chandler has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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