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Utilities

Roger Conrad Answers Your Investing Questions

By Roger S. Conrad, on Jun. 9, 2015

Editor’s Note: Roger Conrad will host an exclusive Live Chat for Conrad’s Utility Investor subscribers today at 2:00 p.m. ET. This is your opportunity to ask Roger any questions you might have about his market outlook or the more than 200 essential-services stocks that he covers in his Utility Report Card. If you haven’t joined Conrad’s Utility Investor, now is the perfect opportunity. Subscribe today and you’ll save $100 and be able to participate in today’s Live Chat! Here’s a sample of Roger’s responses to a few of the questions readers have submitted via email.

Q: Utility stocks have taken a beating in recent weeks. What’s going on and what’s the best strategy?

A: The yield on the 10-year Treasury note has surged to more than 2.4 percent after bottoming at 1.65 percent on Jan. 30, 2015. And with all eyes on when the Federal Reserve will raise interest rates, Treasury yields likely will head higher.

These developments have given investors an excuse to take profits on utility stocks—a tempting prospect after the sector’s huge outperformance last year. The logic behind the selloff in utility stocks holds that rising interest rates reduce the value of future dividends, an outlook that conveniently dismisses the potential for dividend growth.

But over the long run, a stock’s return and dividend growth tend to track the health of the underlying business.

The time to buy a high-quality stock is when it’s cheap. And dividend-paying stocks can slip into value territory when the crowd focuses on interest rates. A number of quality names have already pulled back to attractive valuations, but that doesn’t mean they can’t fall further—markets always overshoot to the upside and downside.

For investors who take the long view, these cheap stocks should generate solid returns in the years to come.

If you’re particularly worried about near-term downside, consider taking a position in ProShares UltraShort Utilities (NYSE: SDP), an exchange-traded fund that gains 2 percentage points for every 1-point decline in the Dow Jones US Utilities Index. With this approach, you’ll have some gains to help offset any losses in your utility stocks.

However, you should direct most of your time and effort into the routine portfolio maintenance you’d do in a normal market: pruning your underperformers and booking some gains on your big winners while adding to positions in best-in-class names that have pulled back below our buy targets.

These moves will help you to ride out a more severe correction while positioning your portfolio for strong gains when the market stabilizes. In either case, you’ll own the best essential-services stocks at excellent entry prices. I hope that helps.

Q: Thanks for the great call on Hawaiian Electric Industries (NYSE: HE). Why did you decide to sell?

A: When NextEra Energy (NYSE: NEE) announced its proposed takeover of Hawaiian Electric Industries, we thought the deal would close without a hitch.

Not only had Hawaiian Electric Industries’ relations with local regulators improved considerably, but the combination with a larger company would also accelerate Hawaii’s transition away from expensive, oil-burning power plants to more renewable energy—one of the state’s main goals.

Holding until the transaction closed would also give us a cheap way to pick up shares of high-flying NextEra Energy, a company with impressive growth prospects. We also thought that the spin-off of Hawaiian Electric Industries’ banking unit could be worth 20 percent more than the targeted $8 per share.

NextEra Energy’s takeover offer is a good deal for Hawaiian Electric Industries’ shareholders. However, the process of closing this deal looks to be more of a marathon than a sprint—and the risk of the transaction falling through has increased.

For starters, despite the endorsement of Institutional Shareholder Services, the deal has yet to secure the approval of 75 percent of Hawaiian Electric Industries’ shareholders, 22 percent of which haven’t voted.

A surprisingly sizable contingent of shareholders also opposes the takeover, a quizzical stance when you consider that Hawaiian Electric Industries’ shares would tumble into the low $20s without the takeover.

Vocal opposition from local companies that specialize in rooftop solar power has also made the deal seem more controversial, though the reasons for this hostility are motivated primarily by self-preservation. Their businesses would take a hit from entrance of a formidable competitor in distributed solar power and utility-scale installations.

These considerations shouldn’t influence regulators, who render their decisions based on whether ratepayers’ access to low-cost, reliable electricity will improve.

Given this hubbub and the potential that NextEra Energy and Hawaiian Electric Industries likely will need to extend the June 10 deadline for shareholder approval, the deal might not go through until next year. Such a delay would increase the near-term risk to our profit.

Although 20-20 hindsight suggests that we should have sold Hawaiian Electric Industries for a slightly higher gain in January, booking a 30 percent gain on a stock on which nobody was bullish isn’t a bad bit of business.

CUI-Evergreen

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