With the yield on U.S. Treasury bonds sitting well below 3%, income investors have to get creative. Those seeking dividend-based cash flow must to be willing to look in less traditional places to find a safe yield. And what could be less traditional than nuclear power?
After the Three Mile Island disaster of 1979, nuclear energy became the forgotten carbon-free source of electricity. However, a small renaissance in nuclear power is happening as we speak, and Exelon Corp. (NYSE: EXC) gives us a great tool to capture the upside from this renaissance – with some solid income, to boot.
Exelon is the largest operator of nuclear power plants in the United States, with 10 plants operating a total of 17 individual reactors. It's the third-largest operator of nuclear plants in the world, and it has a massive barrier to entry around its niche market.
Exelon generates 92% of its electricity from its fleet of nuclear power plants, which together produce enough electricity per year to satisfy the needs of 17 million Americans. Nuclear power plants have the lowest cost per watt generated, compared to hydrocarbon burning plants, like coal or natural gas.
Exelon also has a low carbon footprint, so we know that its dividend won't be affected by the potential passage of cap-and-trade legislation.
Utilities with a monopoly service area historically have provided a great source of income to long-term investors. The savvy investors of days gone by could skip the taxman by holding their high-dividend investments for decades. However, the two biggest risks to income investors have always been bankruptcy and a reduction in the dividend yield.
If you are currently holding Exelon, you are most likely underwater. The stock is down 20% year-to-date, compared to the Standard & Poor's 500 Index, which is flat. However, I would recommend that you continue to hold the stock and use its high-yielding dividend to buy down your entry price. And if you don't yet have a position in Exelon, its current weakness gives us a nice entry on a stock with a solid history of paying dividends.
Exelon common stock yields 4.9%, while continuing to produce regular earnings. The stock price has a trailing 12-month Price/Earnings (P/E) ratio of 11, yet its industry peer group sports an average P/E of 14, which suggests it's undervalued.
Exelon currently has more than $1 billion in cash, while carrying $12 billion in debt. The market cap is currently around $27 billion, giving the company an "enterprise value" of $38 billion. (Enterprise value is often used as an alternative to market value, because it also accounts for such things as the company's debt).
The firm generates $17 billion per year in revenue, so there's ample free cash flow for the company to pay its dividends.
Even better, this revenue stream is almost guaranteed, due to Exelon's ability to provide long-term carbon free sources of electricity to its customers. At these prices, I believe Exelon gives us a nice, safe dividend vehicle to invest in for the long term.
Exelon closed Thursday at $42.48 per share.
Next, I want you to take 1% of your purchase amount and hedge your downside risk by purchasing Excelon put LEAPs (Long-Term Equity Anticipation Securities), good until January 2012. [EXC Jan 2012 $40.000 put (EXC120121P00040000)]
We are going to use 20% of our income stream from the dividends paid by the common stock to hedge the common equity from any additional "flash crashes" that might happen. If Exelon's stock price suffers a significant pullback from here, we should expect some of that risk to be covered by the "insurance" that we've created here.
This strategy gives us a 4% yield with our upside on the stock still open.
There's a second option: If you prefer to increase your income yield even more, I would suggest a written "covered call" strategy. In this case, you would want to write slightly out-of-the-money calls, with expiration in 45 days or less.
You can earn extra income from your short-term, call-writing strategy, while providing someone else the near-term upside in the stock price. In this example you maximize your income by combining the cash flow from your dividends with the cash flow you generate by writing covered calls.
(**) Special Note of Disclosure: Jack Barnes holds no interest in Exelon Corp.
[Editor's Note: Jack Barnes started his career at Franklin Templeton in 1997, working in the company's fund-information department - just as the Asian contagion infected the Asian tiger countries. He launched his own RIA shop in 2003 just as the second Gulf War was breaking out. In early 2006, after he logged a one-year return of nearly 83%, Forbes named Barnes the top stock picker in its "Armchair Investors Who Beat the Pros" competition. His two audited hedge funds generated double-digit returns in 2008. Last summer, Barnes retired to the beach - which is where he writes from now.]
News and Related Story Links:
- The New York Times:
A Comeback for Nuclear Power.
The Basics of Covered Calls.
Long-Term Equity Anticipation Securities: When To Take The "LEAP"?
- Money Morning:
Hot Stocks: OGE Energy Corp. (NYSE: OGE) Is Electrifying Investors' Portfolios
- Money Morning:
The End of the Cap-and-Trade Masquerade Opens New Doors For Investors