Utilities still shine
The last time Maura Shaughnessy was on the phone she sounded confident that utility stocks, some of the market's unlikely stars of the past four years, were finally going to slow down in 2007. So much for predictions.
Shaughnessy wasn't just trying to put a dent in expectations last December, when I declared her Boston Capital's mutual fund manager of the year for her direction of the MFS Utilities fund. There were good reasons to believe those stocks were overdue for a break.
Utilities and other defensive stocks with dividends, like thrifts, and real estate investment trusts, became popular market alternatives five or six years ago after growth investors and their favorite tech firms got hammered.
The Dow Jones utilities average has tripled since the fall of 2002, less than five years ago. Active fund managers who specialize in utilities have produced similar results. As it happens, Boston is full of them.
That kind of performance, coupled with the laws of gravity, led most prudent investors to expect less in 2007.
But the same Dow utilities index is up 16 percent already this year. Around Boston, Shaughnessy's MFS Utilities fund has climbed 16.8 percent so far in 2007. Judy Saryan's Eaton Vance Utilities fund is up nearly 14 percent. Fidelity Select Utilities Growth Portfolio run by Douglas Simmons has climbed 16.5 percent. The Evergreen Utility and Telecommunications fund, managed by Tim O'Brien , has advanced 17.4 percent. You can see links to these funds and more about their performance on the Boston Capital blog at the address at the bottom of this column.
Utilities have remained hot for a few reasons, including the most basic one of all: supply and demand. New supply has not been built to match demand. Companies with power generating assets are still sitting pretty.
"When contracts come up for rebidding, prices go up," says Saryan. "What we're seeing is what you might expect when you step back and see that little money has been spent on utility infrastructure."
Exhibit A: NRG Energy Inc. , a big Texas power producer and a favorite among utility fund managers. Its shares are up about 50 percent this year. "The stand-alone independent power companies have been unbelievably good stocks this year," says Shaughnessy, who counts NRG as her single largest investment.
Another factor that gave utility stocks a bump this year: private equity. When Kohlberg, Kravis Roberts & Co. and TPG Inc. offered to buy Texas power producer TXU Inc. for $32 billion, investors recalculated what other public power assets should be worth.
Some utility stocks have also risen this year expecting some kind of government action on carbon dioxide emissions, which would probably push energy prices higher.
All sounds great, right? But of course there is a catch.
Four years of climbing stock prices have made many utilities expensive. Conventional value-investing calculations won't explain why some of these stocks are worth their current price. Price to earnings ratios are high. Dividend ratios are low.
Investors who talk up those stocks sound more like growth investors. They project business farther into the future to support current stock prices, or find new ways to put higher values on existing assets.
"Frankly, we've been focusing internationally to find better values overseas," says Shaughnessy.
But fund managers say the fundamentals of the utilities business, particularly supply and demand, remain strong and generate lots of cash. Power is a cyclical business and investors are still riding high. But cycles go up and down and the top is rarely a good place to jump aboard.
