INSIGHTS

On August 29, 2012

Utility Stocks Continue to Reward Investors

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(as of August 20, 2012)


Performance: Utility stocks, as measured by the Philadelphia Stock Exchange Utility Index, rose 2.3% in the month of July, surpassing a 0.3% increase in the S&P 500 Composite Index. The utility index has now outperformed the general market three of the last four months with only the month of June (utilities up 3.6% versus a 4.0% increase for the market) breaking the utilities’ streak. We attribute the strength in the utility sector to continued declines in long-term interest rates and an expected increase in earnings due to warm weather and higher commodity prices. We generally do not get excited about the short-term impacts of weather, but acknowledge that short-term traders may be purchasing the shares of utility stocks in anticipation of strong earnings results for the September quarter to be reported in October.

Valuation: With the rise in utility stock prices, valuations have become more expensive. The median price as a multiple of 2013 earnings for the 82 utility stocks we follow has risen to 15.3X as of July 31, 2012. This multiple is near the upper end of utility stock’s historical trading range, as is the case for most conservative, income-oriented investments. Admittedly, the case for utility stocks is more difficult to make than three months ago. However, we continue to believe the issues causing the strength in the group relative to the overall market (Europe, weak economic conditions, low interest
rates) are likely to continue, and that utility stocks could continue to rise.

June-Quarter Earnings: June-quarter earnings for utility stocks were generally within expectations. In analyzing the results, a few trends emerged. First, earnings were down for gas utilities without weather protection riders (a mechanism that allows utilities to recover some/all of their returns from the effects of the weather) in their rates due to warm weather early in the quarter. Second, a shift by energy producers towards oil and liquids production and away from dry gas has had an adverse affect on natural gas liquid prices, thus hurting some utilities with energy processing divisions. Third, storms in the Northeast should result in higher operating costs for many utilities in the upcoming September quarter. Fourth, these higher costs should more than be offset by the positive effects of extremely warm weather in July. Fifth, drought conditions have had a positive impact on water utilities, a trend that could continue into the next quarter.

Conclusion: We continue to believe that utility stocks provide an attractive return for conservative investors seeking income with the potential for capital appreciation. Although valuation multiples are near historically high trading levels, the same can be said for other conservative, income investments. With a median dividend yield of 3.8% as of July 31, 2012 and estimated earnings and dividend growth of 3-5%, we estimate that the typical utility stock could provide investors with a total return of 6-9%. Such a return represents a significant premium over the 2.6% yield provided by 30-year government bonds. Enough premium, in our opinion, to adequately compensate investors for the added risks involved in investing in utility stocks.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com


The information contained herein is obtained from Confluence Investment Management LLC and believed to be reliable. The information is not warranted as to completeness and accuracy and is subject to change without notice. The foregoing has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security.


Advisors Asset Management, Inc. (AAM) and Confluence Investment Management LLC are not affiliated and the views expressed in this commentary are not necessarily that of AAM.
Confluence Investment Management LLC is the Portfolio Consultant to the Confluence Utilities Portfolio. The Portfolio Consultant is not an affiliate of Advisors Asset Management, Inc. (AAM), the sponsor of this trust.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.