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Income Investing

Utility Stocks: A Capital Idea

By Roger S. Conrad, on Feb. 13, 2016

When the economy booms or a specific industry undergoes a secular expansion, capital flows freely—that was the case for all things energy until oil prices began to tumble in summer 2014.

Now, growing concerns about the US economy’s health and the potential contagion from the energy sector have precipitated a meltdown in the high-yield bond market.

During the boom times, names making big (but ultimately dubious) promises thrived. For example, investors threw billions of dollars at SolarCity Corp (NSDQ: SCTY), which boldly asserted that rooftop solar power would end electric utility’s century-long dominance.

In the world of energy-focused master limited partnerships (MLP), investors flocked to initial public offerings that owned crummy assets but promised double-digit distribution growth, while shunning time-tested winners like Enterprise Products Partners LP (NYSE: EPD) that took a more conservative tack.

How times have changed. Junk-rated corporations face much higher borrowing costs, while MLPs have started to fund scaled-back growth initiatives with cash, credit lines, asset sales and private securities transactions to avoid the public markets.

Money is tight. And individual and institutional investors’ appetite for risk continues to diminish. In this environment, companies closed out of the capital markets must fall back on their own resources until conditions improve or pair up with a stronger rival.

These challenges create massive opportunities for names with superior costs of capital, especially in a North American energy landscape that’s undergoing huge changes.

Thanks to their highly visible cash flow, utilities still enjoy low costs of capital, enabling them to pursue two major growth opportunities at the expense of the competition: the rise of gas-fired power generation and solar power.

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