Utilities have been red-hot in the past month, as subscribers to my private advisory service – The Strategic Advantage – have earned double-digit profits on power generators from Vermont to Arizona.
Let's take a look at one of my favorites now: OGE Energy Corp. (NYSE: OGE), the parent company of electric utility Oklahoma Gas and Electric Co. and natural gas pipeline operator Enogex LLC.
OGE exemplifies our summer theme: Low-risk asset growth, stable earnings and rising dividends. The stock has performed very well for us – it's up more than 11% this month. OGE also pays a 3.7% dividend.
We've talked a lot about utilities, but it is hard to overstate their importance. Businesses need electricity to run production lines, operate computer servers, manage inventory, and light buildings. A power outage that only lasts a few minutes can cost a business thousands of dollars, because machines need to be readjusted so that products can be correctly assembled.
Oklahoma Gas and Electric is the utility unit of OGE and provides electricity to nearly 800,000 customers in Oklahoma and western Arkansas. It is a sizeable utility with $3.14 billion in annual sales and a $3.83 billion market cap. OGE mainly generates electricity from natural gas because the utility receives excellent distribution rates from Enogex.
The utility's profit margins are a healthy 8.5%, and year-over-year earnings grew at an astonishing 44% due to a rate increase. Low natural gas prices have also kept expenses down.
OGE is benefiting from this hot summer as consumers and businesses habitually use air conditioning. June temperatures were the seventh warmest ever recorded in Oklahoma history. July temperatures were just as hot.
The relative strength of the local economy also helps OGE's bottom line. Oklahoma City has one of the lowest unemployment rates in the nation at 6.7%. The company is adding customers near its usual 1% growth rate and has seen a gradual improvement in usage. Industrial sales were up 5% in the first quarter and have increased for three consecutive quarters.
In addition to Oklahoma Gas and Electric, OGE controls Enogex, the operator of an extensive natural gas pipeline network and several processing facilities. The subsidiary transports natural gas from the wellhead and delivers the raw form to processing plants. Enogex then distributes the gas to large consumers such as electric power plants, gas utilities, and industrial customers.
Unlike its utility counterpart, Enogex is unregulated and affected by swings in natural gas prices. However, the pipeline operator has long-term contracts to supply natural gas to its sister company, Oklahoma Gas and Electric. This agreement decreases revenue volatility.
Oklahoma is America's third-largest gas producing state, and Enogex's network is strategically located at the center of three basins. The 2009 opening of the Clinton processing plant is also improving earning stability as Enogex processes more fixed-fee, high volume transactions.
The gas distributor expects gathering and processing volume to grow 7% and 12%, respectively, in 2010. When the economy recovers and natural gas prices rise, Enogex's pipeline network will provide an upside for OGE that other utilities lack.
Chief executive Peter Delaney has been with the company for years and previously served as chief operating officer. He is required to own five times his base salary in OGE stock, which helps align his financial interests with that of shareholders.
Historically, OGE has achieved healthy returns on its invested capital despite operating in a tough regulatory environment. Public officials only approved half of OGE's recently requested rate increase and rejected a proposal for a new coal power plant.
Analysts expect OGE to earn $3.07 a share in 2011, valuing the stock at 12.8-times forward earnings. My model suggests a slightly higher $3.15 a share. Considering that OGE has been valued at 14-times earnings in the past, we are looking at a price target of at least $44.
OGE is still a good buy for income-oriented equity investors, especially since utility companies are being revalued in the wake of the death of cap-and-trade legislation.
[Editor's Note: Money Morning Contributing Writer Jon D. Markman has a unique view of both the world economy and the global financial markets. With uncertainty the watchword and volatility the norm in today's markets, low-risk/high-profit investments will be tougher than ever to find.
It will take a seasoned guide to uncover those opportunities.
Markman is that guide.
In the face of what's been the toughest market for investors since the Great Depression, it's time to sweep away the uncertainty and eradicate the worry. That's why investors subscribe to Markman's Strategic Advantage newsletter every week: He can see opportunity when other investors are blinded by worry.
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