Buy These Utilities Instead of Bonds

Falling interest rates have rekindled investor interest in high-yielding utility stocks, such as these five. All of them have a long history of increasing dividends. Unlike interest payments on bonds, dividends qualify for the dividend tax credit. As well, stocks offer you open-ended returns, so they can give you protection against inflation. Bonds can’t provide this protection, because they are fixed-return investments. We see all five of these utilities as buys for long-term gains and income.

TRANSCANADA CORP. $39 (Toronto symbol TRP; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 540 million; Market cap: $21.1 billion; SI Rating: Above average) operates a 59,000-km network of natural gas pipelines in Canada and the United States. This business supplies 70% of its profit. The remaining 30% comes from its electrical power operations.

TransCanada aims to cut its reliance on its regulated pipeline business with new growth projects. These include the Keystone pipeline, which will transport crude oil from Alberta’s oil sands to the U.S. Midwest. Initial deliveries should begin in late 2009.

The company recently agreed to sell half of Keystone to U.S.-based oil giant Conoco- Phillips for an undisclosed sum. TransCanada had earlier granted ConocoPhillips this option as part of a long-term shipping agreement. That will cut the risk of this project, as well as its projected cost of $3 billion.

TransCanada is also expanding its gas storage operations. In early 2007, it spent $3.4 billion U.S. for natural gas pipelines and storage facilities in Texas and other U.S. states.

Demand for storage services is growing as more producers prefer to temporarily store their excess gas instead of selling it when prices are low.

Thanks to acquisitions and strong growth at its existing operations, TransCanada’s revenue in 2007 rose 17.3%, to $8.8 billion from $7.5 billion in 2006. Earnings before one-time items grew 18.9%, to $1.1 billion from $925 million. TransCanada issued new shares to help pay for its purchases. Consequently, per-share earnings rose just 10.0%, to $2.09 from $1.90. Cash flow per share rose 1.8%, to $4.93 from $4.84.

The strong results let TransCanada increase its dividend 5.9%. The new annual rate of $1.44 a share yields 3.7%. The stock trades at 17.2 times its likely 2008 earnings of $2.27 a share.

TransCanada is a buy.

CANADIAN UTILITIES LTD. (Toronto symbols CU $48 (Class A) and CU.X $47 (Class B); Income Portfolio, Utilities sector; Shares outstanding: 125.4 million; Market cap: $6.0 billion; SI Rating: Above average) is a leading distributor of natural gas and electricity in Alberta. It has over 1 million customers in nearly 300 communities.

The company also operates independent power plants in other parts of Canada, the UK and Australia. ATCO Ltd. controls about 74% of the company’s class B voting common shares.

Among Canadian Utilities’ overseas investments is a 25.5% stake in the Barking power plant in London, UK. Due to the recent failure of a steam turbine, the plant will operate at 60% of capacity for the next 45 days. The outage will cut Canadian Utilities’ earnings in the fourth quarter of 2007 by $5 million to $10 million.

To put that in context, the company earned $72.2 million in the three months ended September 30, 2007, up 8.1% from $66.8 million a year earlier. Earnings per share rose 9.4%, to $0.58 from $0.53. Revenue fell 11.6%, to $489.9 million from $553.9 million, partly due to lower gas prices. Cash flow per share rose 1.7%, to $1.19 from $1.17.

Strong economic growth in Alberta should increase Canadian Utilities’ earnings in 2008 to $3.00 a share. The stock trades at 16.0 times that estimate. The $1.33 dividend yields 2.8%.

Canadian Utilities is a buy. The more liquid class ‘A’ non-voting shares are the better choice.

EMERA INC. $21 (Toronto symbol EMA; Income Portfolio, Utilities sector, Shares outstanding: 111.4 million; Market cap: $2.3 billion; SI Rating: Average) is the main supplier of electricity in Nova Scotia. It has 475,000 residential, commercial and industrial customers. Emera also distributes power to 110,000 customers in Bangor, Maine.

Emera is now investing heavily in several new growth projects. For example, it plans to spend $350 million building the Brunswick Pipeline, which will move natural gas from a proposed liquefied natural gas (LNG) terminal in Saint John, New Brunswick to markets in the Northeastern United States. Emera has a 25-year deal with the owners of the LNG facility, which cuts the risk of this investment.

The company also paid $46 million U.S. for 50% of the new Bear Swamp hydro-electric facility in northern Massachusetts, plus $22 million U.S. for 19% of the main electrical utility on the Caribbean island of St. Lucia.

These are big commitments for Emera, which earned $40.9 million in the third quarter of 2007. That’s more than double the $19.5 million it earned in the year-earlier quarter. Per-share earnings rose 94.4%, to $0.35 from $0.18, due to more shares outstanding. Revenue rose 13.9%, to $310.3 million from $272.4 million. Cash flow per share improved 37.3%, to $0.81 from $0.59.

These new assets enhance Emera’s long-term earnings potential. They also help Emera cut its reliance on its main Nova Scotia Power subsidiary, which accounts for 80% of its earnings.

The stock now trades at 15.3 times its projected 2008 earnings of $1.37 a share. The company recently raised its dividend for the second time in six months. The new rate of $0.95 yields 4.5%.

Emera is a buy.

FORTIS INC. $29 (Toronto symbol FTS; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 154.9 million; Market cap: $4.5 billion; SI Rating: Above average) provides electricity and natural gas to over 2 million customers in five Canadian provinces. It also owns power companies in the Caribbean, as well as hotels and commercial real estate in Canada.

Much of Fortis’s growth in the past few years has come from acquisitions aimed at reducing its exposure to Atlantic Canada. Its biggest purchase to date was the $3.7 billion acquisition of the natural gas distribution business of Terasen Inc. in May 2007. This business supplies 95% of British Columbia’s natural gas users.

Thanks to these new assets, Fortis’s revenue in the three months ended September 30, 2007 jumped to $651.0 million from $341.9 million a year earlier. However, earnings fell 16.8% to $32.3 million from $38.8 million. Terasen Gas makes most of its money in the winter, and reported a loss of $3.7 million in the quarter. Per-share earnings fell 44.4%, to $0.20 from $0.36, on more shares outstanding.

Fortis now plans to build a liquefied natural gas storage facility on Vancouver Island. The project will cost $175 million to $200 million, and should be ready in late 2011. Owning its own storage facility will let Fortis improve the efficiency of its gas pipelines in B.C.

Fortis should earn $1.59 a share in 2008, which gives it a p/e of 18.2. The $1.00 dividend yields 3.4%.

Fortis is a buy.

TRANSALTA CORP. $32 ( T o r o n t o s ymb o l T A ; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 201.4 million; Market cap: $6.4 billion; SI Rating: Average) owns 50 unregulated power plants in North America and Australia.

In late 2006, the company closed the coal mine that supplied its plant in Centralia, Washington. It successfully replaced this fuel with coal from a mine in Wyoming.

Due to increasing output at Centralia, plus higher power rates, TransAlta’s earnings in 2007 rose 13.1%, to $264.3 million from $233.8 million in 2006. These figures exclude non-recurring items. Per-share earnings rose 12.9%, to $1.31 from $1.16, while cash flow per share grew 14.2%, to $3.86 from $3.38. Revenue improved to $2.8 billion from $2.7 billion.

TransAlta has raised its dividend for the first time since 1999. The new annual rate of $1.08 a share, up 8% from $1.00, yields 3.4%.

TransAlta spent $74.9 million on share repurchases in 2007. The company is now considering selling its struggling Mexican plants, which would give it more cash for stock buybacks and dividends.

Earnings in 2008 should grow to $1.45 a share, and the stock trades at 22.1 times that estimate. That’s higher than most utility stocks, but still reasonable in light of TransAlta’s strong growth potential.

TransAlta is a buy.