In hard times, utilities can be a sound investment

January 05, 1992|By Julia C. Martinez | Julia C. Martinez,Knight-Ridder News Service

Investors seeking a safe hideaway for their money this year will continue to find a haven in utility stocks.

Utility issues, considered a good defensive vehicle in hard times, offered a refuge for investors during the economic uncertainty of 1991.

As interest rates tumbled, investors took their money out of CDs and money-market mutual funds in quest of higher yields.

Toward the close of the year, the average yield of the highest-dividend-paying utilities, 7.5 percent, was about twice that of the average New York Stock Exchange dividend-paying stock, 3.1 percent. That's a few percentage points more than rates being paid by money-market funds.

"People are looking for yield substitutes. Utilities, in that sense, look attractive," said Peter Cooke of Pierson Capital Management in Philadelphia.

Investors are not buying utilities for growth. They're buying them for income, Mr. Cooke said.

"On a defensive basis, they're still OK," he said. "We're not buying utilities, but utilities are an attractive defense area to be in, given the economic outlook."

Like bonds, electric-utility stocks tend to rise in price when falling interest rates enhance the attractiveness of the dividends they pay.

Furthermore, utility stocks can offer something bonds typically cannot: the hope of future dividend increases to counter the erosive effects of inflation.

In the last 12 months, the dividends of many utility companies were raised. As dividends increase, stock-price appreciation generally follows.

However, if the economy picks up steam and interest rates rise, financial advisers say, investors might want to move out of utility stocks and into more cyclical or growth- oriented equities.

"I can't see buying a [utility] company that yields 5.5 percent if you can get that in your checking account," said Edward J. Tirello Jr., analyst with Smith Barney, Harris Upham & Co. "But I do have an interest in companies yielding 7.5 percent."

Charles Carlson, editor of the investment advisory service Dow Theory Forecasts in Hammond, Ind., warns that not all utilities are created equal.

Also, for some electric-utility stocks, the biggest gains already might have occurred, Mr. Carlson said.

"Utilities remain excellent investments for conservative, income-oriented investors," he said.

"But selectivity is crucial, and the current environment favors utilities with bright growth prospects," he cautioned.

The outlook for energy company stocks, meanwhile, depends largely on what happens to the price of oil and gas, since the companies' stocks move up and down with the price of those commodities.

The oil industry also faces tighter profits as companies spend more money to comply with stricter environmental laws.

Energy stocks, as a group, tumbled in 1991 as oil and gas prices sank.

In November, they dropped 11 percent, "quite possibly the worst month of that group since the crash of 1987," said Alan Gaines of the New York investment firm Gaines Berland Inc.

Mr. Gaines attributes some of the losses to new clean-air legislation in California that, if enacted nationwide, could cost refiners $2 billion to $6 billion for retooling their plants and making reformulated gasoline.

While oil and gas prices could rise in the near-term as winter demand for heating oil and gas picks up, some analysts believe prices are headed down by the end of the year as Kuwait and Iraq pump more oil onto the market.

"We see a strong likelihood of oil prices' declining, in spring mainly, but [also over] the course of the year due to a fight for market share among OPEC members," said William Randol, analyst with First Boston Corp.

First Boston is advising its clients to reduce their exposure in oil stocks.

"Realizing that we may be early -- but, we are convinced, $H ultimately right -- we are recommending that investors use the near-term seasonal strength in international oil shares as an opportunity for lightening up their portfolios in anticipation of problems in the oil market next spring," Mr. Randol said.

Given a lower-price scenario, Mr. Randol recommends investing in diversified companies heavily involved in the refining and marketing end of the business, since they would benefit from lower raw-materials prices.

From an earnings standpoint, the safest stocks for investors in this category are the largest, most diversified companies: Exxon Corp., Royal Dutch Shell and, to a lesser extent, Mobil Corp., Mr. Randol said.

Exxon and Royal Dutch Shell, in particular, are less vulnerable to a sharp drop in oil prices by virtue of their deeper pockets and large worldwide refining and marketing operations.

Mr. Gaines, whose firm specializes in energy stocks, advises underweighting in oil stocks, but recommends some major internationals.

"If you're not looking to hit a home run, international oil companies could be a good investment," he said. "For example, the stock won't go from $65 to $125, but it might go from $65 to $78."

For more aggressive investors, Mr. Gaines recommends some small oil-exploration companies with healthy balance sheets whose stocks "have the potential to double, triple and quintuple" over time.

Coda Energy, American Exploration and Snyder, all Texas-based, are well-managed companies with combined general and administrative expenses and interest expenses of less than 20 percent of revenue per quarter, an important factor to consider, he said.

Whether investors choose big international oil companies or domestic energy companies, Mr. Gaines advises them to check balance sheets.

"If a company has a good balance sheet, you don't have to worry if the price of oil or gas goes lower," he said.

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