Sunday, April 22, 2007

Utility Stocks: Ready For a Short Circuit?

The best performing sector over the last 12-months has been utility stocks. The utility sector is up 32.48% versus the next best performing sector, telecommunications, up 30.83%. Is the low level of indicated dividend yield an indication utility stocks are overvalued? One factor driving utility share prices higher has been the flow of private equity dollars into this sector. Specifically, Texas Utilities (TXU)) is involved in a deal to go private led by Kohlberg Kravis Roberts & Co. and TPG Inc., formerly known as Texas Pacific Group.

In an article today by Daniel Hauck and Michael Tsang of Bloomberg, they cite some data that might suggest utility shares are approaching an overbought level.
  • The average yield for power companies worldwide last month fell below both U.S. and European interest rates for the first time since September 2001.
  • Some investors are taking notice: firms overseeing about $12.3 trillion were net sellers of utility stocks in April, State Street Corp. says.
  • The drop in dividend yields may signal utility stocks are overvalued, if history is any guide. The last time the yield on the S&P 500 Utilities Index fell below the current level was in 2000. The gauge climbed to a record on the second-to-last trading day of the year, before a two-year slide.
  • They've defied history since the current bull market began in 2002. The group has been the second-best performer among 10 industries in the S&P 500, in part because U.S. interest rates tumbled to four-decade lows, increasing the attractiveness of shares that pay the highest dividends.
  • The utilities index gained 13 percent this year, extending its advance since October 2002 to 173 percent. That's better than every industry group except energy stocks and almost double the S&P 500's 91 percent increase.
  • The dividend yield on the U.S. utilities gauge has slipped to 2.86 percent from 6.31 percent at the start of the bull market. It's now 0.46 percentage points above the level reached in April 2001, and that was the lowest since at least 1989, according to Bloomberg data.
  • Endowments, pension funds and other institutions became net sellers of utilities at the end of 2006, according to the brokerage arm of Boston-based State Street, the world's third- largest custodian of assets. This month, selling of U.S. utilities was the second-highest among 10 industry groups, behind only industrial companies, according to State Street.
  • Institutions ``haven't been the ones driving the price up recently,'' said Sam Burns, senior U.S. equity strategist at State Street Global Markets. ``They may think that if there's all this deal activity going on, that's the time to sell.''
  • SAC Capital, a $12 billion hedge fund run by Steven Cohen in Stamford, Connecticut, increased its holdings of utility stocks among its assets by 1.6 percentage points in the fourth quarter, according to data compiled by Bloomberg. Jonathan Gasthalter, a spokesman for SAC, declined to comment.

  • D.E. Shaw founder David Shaw, who advised former President Bill Clinton on science and technology, boosted his holding in Mirant more than sixfold to 2.33 million shares in the fourth quarter. The New York-based fund manages $29 billion. Kari Elassal, spokeswoman for D.E. Shaw, declined to comment.

  • Bruce Kovner's Caxton, a New York-based fund that oversees more than $14 billion, almost doubled its stake in Mirant in the fourth quarter.

  • Caxton, D.E. Shaw and Kenneth Griffin's Citadel Investment Group LLC, a $13.4 billion hedge fund based in Chicago, all held stakes in Houston-based power producer Dynegy Inc., according to filings as of Dec. 31 compiled by Bloomberg.

The interesting fact in the Bloomberg article is many institutional investors have trimmed their weighting in utility shares. At this time it appears the main driver of the flow of funds into utilities is coming from hedge funds. Hedge funds can be thought of as hot money and can change their investment position in a very short period of time; thus creating volatility in the price of utility stocks.


Utility Stocks Captivating Hedge Funds Incite Industry Bears
By: Daniel Hauck & Michael Tsang
April 23, 2007

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