December 23, 2009 / 4:54 PM / 11 years ago

Utility rally reduces sector's appeal

BOSTON (Reuters) - The once-lagging utility sector has been on a tear over the past month — which has top-performing utility fund manager Maura Shaughnessy of MFS Investment Management holding steady on some stocks she had been snapping up earlier this year.

The recent hot streak for the sector, which has outperformed the eight other major market segments, has greatly reduced buying opportunities, Shaughnessy said in a recent interview at her Boston office.

“Whether it’s people hiding at year end or something else, it’s a really tough situation now,” said Shaughnessy, who has run the $2.7 billion MFS Utilities Fund since it opened in 1992.

In the past month, the Utilities Sector SPDR has gained 6.6 percent, better than any of the other eight major sectors and almost triple the 2.4 percent gain in the Standard & Poor's 500 Index .SPX. But for the year, utilities fared worst among the major sectors with a rise of just 7.4 percent, far behind the S&P 500's 23.8 percent increase.

Shaughnessy’s fund is up 32.9 percent, double the average gain of utility-oriented mutual funds, according to data from fund tracker Lipper.

As usual, Shaughnessy got to some of the top stocks of the year before her peers. She was buying “boring” utilities like Wisconsin Energy (WEC.N) and Sempra Energy (SRE.N) until November, when other investors caught on.

Such electric and natural gas utilities face heavy regulation at the state level, which offers both opportunities and pitfalls. Shaughnessy said she generally favored companies in states where regulators allow “reasonable” rates of return on new projects.

So she’s a fan of CMS Energy (CMS.N) and DTE Energy (DTE.N), which operate in Michigan, and Dominion Resources (D.N) in Virginia. She’s avoiding regulated companies doing a lot of business in Connecticut and Florida.

Now she’s looking for bargains among the beaten-down independent power generating companies. With the decline in industrial demand for electricity, many of the independents are suffering.

“It’s going to take them a while to recover, but we might be able to buy some names cheap,” she said, declining to disclose specific companies.

The MFS fund is allowed to buy non-U.S. utilities, and Shaughnessy is looking hard at Brazil companies, many of which trade at much lower ratios of price to earnings and free cash flow than similar U.S. operators.

Eletropaulo Metropolitana ELPL3.SA may be “very boring,” but is a “free cash flow machine” whose earnings are also growing, she says. Water utility Copasa (CSMG3.SA) is another of her top picks from Brazil.

Low prices for natural gas have hurt producers, but are a boon for companies that process it into other products. So-called midstream producers buy gas as a raw material to make liquid components like ethane and propane, whose prices are more closely tied with those of oil. Many such processors also own gas distribution businesses, so they are categorized as utilities.

The current environment of high oil and low gas prices benefits midstream companies with diversified gas operations like EQT Corp (EQT.N), Questar Corp STR.N and Williams (WMB.N) as well as OGE Energy (OGE.N), an Oklahoma utility with a major processing unit, Shaughnessy said.

At the same time, she is less than sanguine about the prospects for many natural gas producers, saying they’ve raised too much money to expand operations with prices remaining so low.

“Natural gas prices are just sucking wind,” she says.

Reporting by Aaron Pressman; editing by Lisa Von Ahn

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