Regulated Utilities: Stock Selection Drives Strong Performance …………… 3
Currently, we believe the best way to invest in regulated utilities is to buy superior total return stories
(yield + expected earnings growth) at a discount. Right now these stocks are turnaround ideas: companies
that have suffered an economic or regulatory setback that has temporarily (we think) depressed returns.
We also think shares of healthier names with low payout ratios can sometimes be bought cheaply, offering
superior earnings growth and lower capital market risk.
Stock Picks …………… 4
Overweights: Turnaround and earnings growth driven total return ideas.
AEP: One of the most levered companies in our universe to a recovery in manufacturing
CMS and PCG: Constructive regulatory regime supports EPS growth.
TE: Get paid to wait for a recovery in returns at Tampa Electric.
Underweights: Pricing reflects their defensive profile, or discounts too much.
DTE: Dividend yield is high, but consolidated EPS looks flat through 2011.
NST: We see structural risk to long-term earnings power.
XEL: Stock has outperformed since mid-2008 given its defensive profile. While not expensive, it is fully priced.
Industry Debates Summary …………… 5
Debate 1: Will Utilities Underperform in an Economic Recovery? …………… 6
We think stock selection can work in almost any market.
Debate 2: How Critical Is Capital Market Access to Fund Growth? …………… 7
Utilities require capital, but we think the group has good credit quality.
Debate 3: How Will Climate Change Legislation Affect the Group? …………… 9
A carbon cap on utilities with a cap-and-trade system will raise power prices. But we think the cost will eliminate
the rate advantage in states where power is coal-centric. This concern could be mitigated if free allocations are
given directly to consumers. Carbon mitigation investments are far out on the horizon.
Debate 4: How Should Regulated Utility Stocks Be Valued? …………… 11
Our dividend discount model has been useful in deriving P/E multiples. Dividend yield vs. corporate bond yields
is a more relevant barometer, we think.
Overweights …………… 17
American Electric Power: Material leverage to an economic recovery.
CMS Energy: Stable regulatory backdrop supports EPS growth despite economy.
PG&E: Stable regulatory backdrop supports EPS growth despite economy.
TECO Energy: Get paid to wait for a recovery in returns at Tampa Electric.
Underweights …………… 30
DTE Energy: Dividend yield is high, but we see flat consolidated EPS.
NSTAR: We see structural risk to long-term earnings power.
Xcel Energy: XEL shares discount defensive characteristics, with little upside.
Equal-weights …………… 40
Con Edison: Rate base growth drives EPS in a tough regulatory environment.
Duke Energy: Carolinas rate cases likely to be key driver over next 12 months.
NV Energy: Wait for 2011 consensus estimates to come down before buying.
Pinnacle West: Proposed rate settlement is key to PNW’s financial outlook.
Progress Energy: Rate case is near-term issue, but nuke plant build is the story.
Southern Company: P/E premium sustainable assuming Georgia rate case is constructive.
Westar Energy: Rich on near-term EPS, but rationally priced to earnings power.
Wisconsin Energy: Wait for a pullback to buy a superior total return story.
Appendix ……………….65