Japan's Nuclear Fallout Creates Opportunities for Utility Stocks

Editor's Note: This story has been updated since its original publication in the June issue of Kiplinger's Personal Finance magazine.

Even before the Japanese nuclear reactor crisis, U.S. utility stocks were undergoing a minor meltdown. The price of natural gas had crashed, aiding utilities that use gas to generate electricity but putting pressure on earnings of companies that rely on other forms of energy, such as coal and nuclear power, to turn on the lights. Japan's reactor crisis further slammed share prices of utilities with nuclear facilities, as the industry trembled over the likelihood of increased regulatory scrutiny and potentially costly safety upgrades.

Now analysts say that dividend yields on some utility stocks are so high that they can make sense even if stock prices continue to languish. "The whole industry is a bit stagnant in terms of stock-price appreciation, but these yields are pretty attractive for the person with a long time horizon," says Justin McCann, an analyst at Standard & Poor's. "If you wait until there's a turnaround in the market, people who want the dividend will have missed the opportunity."

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To be sure, risks remain. Until recently, nuclear power had been on the verge of reinventing itself as a source of clean energy worthy of significant government backing. Now, national legislators and politicians in every hamlet near a nuclear plant are calling for inspections and reviews of plant safety. There's a good chance that construction of new plants will slow and the cost of maintaining existing facilities could rise. But investors are often rewarded for taking calculated risks. Exelon (symbol EXC) and PPL Corp. (PPL) look particularly attractive, says Gary Hovis, of Argus Research.

Chicago-based Exelon is the nation's largest producer of nuclear energy. Not surprisingly, its stock price got hit hard when the back-to-back blows of a historic quake and a tsunami disabled Japan's Fukushima Daiichi nuclear plant. Exelon shares plunged from $43 to $39 within a matter of days, before rebounding to $42 (all prices and related data are as of the June 10 market close). Since then, Exelon has been working hard to assure investors, regulators and the public at large that its plants are well equipped to handle quakes and are extremely unlikely to be swamped by a tsunami given their geography (Illinois, Pennsylvania and five miles inland from New Jersey's Barnegat Bay).

Exelon yields 5.0%, compared with 4.4% for the average dividend-paying domestic utility. The stock looks cheap on a price-earnings basis, selling at ten times estimated 2011 profits of $4.07 per share, compared with an industry average of 13.1. The company is also a significant competitor in the unregulated power markets and is likely to be a big beneficiary of any rise in natural gas prices. McCann expects the stock to hit $47 in 12 months; Hovis predicts $50.

Hovis recommends PPL Corp., the Allentown, Pa.-based parent of the old Pennsylvania Power and Light, for many of the same reasons. The stock took a beating in the first quarter, sinking from $27 to as low as $24, before recovering back to $27. PPL, which operates in the Mid Atlantic states, Kentucky and Tennessee, yields 5.2% and sells for less than ten times projected 2011 earnings of $2.61 per share. "As soon as the economy picks up a head of steam, natural gas prices are going to rise, power prices will go up, and both PPL and Exelon will see outsized appreciation," Hovis says. "They're really undervalued right now."

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