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Stay Defensive with Blue-Chip Dividend-Paying Stocks

February 05, 2012 | About:
Gordon Pape

Gordon Pape

17 followers
We're one month into 2012 and the world hasn't fallen apart yet. In fact, there are some encouraging signs out there. The U.S. economy grew at its fastest pace in 18 months in the fourth quarter of 2011, expanding 2.8% on an annualized basis. The U.S. housing market, although still very weak, showed signs of stirring in December as existing home sales rose 5%. U.S. employment numbers released Friday came in better than expected.

Stock markets are reacting with restrained optimism, having just completed their best January in many years. The S&P/TSX Composite Index gained 4.2% during the month while in New York the S&P 500 added 4.4% while the Dow was ahead 3.4%. The upward momentum continued into the first three days of February and the Dow is at its highest point since May 2008.

So are we out of the woods yet? No - in fact, we aren't anywhere near it, as the U.S. Federal Reserve Board signalled when it announced that record low interest rates will be maintained until the end of 2014. There are still many uncertainties out there and a recession cannot be ruled out.

That means prudent investors need to stay defensive. It's not time to abandon your bonds or blue-chip dividend-paying stocks. These should continue to form the core of your portfolio.

The problem is that we don't have a huge selection of top-quality defensive Canadian stocks from which to choose. The best ones are already on our Recommended List, including Enbridge, TransCanada, BCE, Tim Hortons, Canadian Utilities, and Fortis. If you want more names to add to your holdings, you have to look south.

One of the areas on which to focus is U.S. utilities. There are many of these stocks available and most share two common traits: relative price stability and an attractive dividend yield. One that I like is Atlanta-based Southern Company which is celebrating its 100th anniversary this year. Here's some background.

Southern Company (SO)

Southern traces its roots back to the founding of Alabama Traction, Light & Power on Jan. 5, 1912. There's a Canadian connection here; the original company was actually incorporated in Montreal and funded mainly by British investors, even though its operations were in the Deep South.

Over the ensuing years, the company aggressively expanded and today it provides electricity to most of the U.S. south-east including Alabama, Georgia, south-eastern Mississippi, and the Florida panhandle. Most of Southern's generating plants use fossil fuels or hydro but the company also has three nuclear generating stations and is in the process of constructing America's first 21st century nuclear energy facility in Georgia.

Southern owns 42,000 megawatts of generating power which it delivers directly to homes through some 27,000 miles of transmission lines, 3,700 substations, and 300,000 acres of right of way. The transmission assets alone are worth an estimated $6.2 billion (dollar figures in U.S. currency). Southern has 4.4 million customers.

As well, the company controls SouthernLINC Wireless, a communications network with a 127,000 square-mile coverage area in the Southeast U.S., and Southern Telecom, a fibre optic wholesaler.

Southern is an attractive buy for your portfolio for three reasons: modest growth potential, a good dividend, and downside protection.

Growth potential: The company's growth potential arises from its operational base. The U.S. Southeast until recently was one of the fastest growing areas of the country and that growth is expected to resume once an economic recovery takes hold. As it does, Southern's profit potential will increase.

Even in a slow economy and with flat residential growth, the company reported earnings of $2.2 billion ($2.57 a share) for fiscal 2011, up from $1.97 billion ($2.37 a share) in 2010. On an earnings per share basis, that represents an increase of 8.4% which is very good for a regulated company, especially in weak economic times.

Cash flow. The stock pays a quarterly dividend of $0.4725 ($1.89 a year). That translates to a yield of 4.3% annually based on Friday's closing price of $44.30. Note that Southern does not qualify for the Canadian dividend tax credit. Also, there is a 15% U.S. withholding tax on dividends paid to Canadian non-registered accounts although that can be recovered through the use of the foreign tax credit.

Downside protection. No stock is immune from a broad market collapse but the utilities usually fare better than most. During the crash of 2008-09, Southern fell from a mid-year 2008 high of $38.62 to a low of $27.14 during the week of March 9/09, a loss of 29.7%. That's a significant decline but it was nowhere near as bad as the Dow Jones Industrial Average which lost more than 50% in the same period. In the market plunge of August 2011, the stock declined only 6.8%.

Southern shares have been trending well above their 50-day and 200-day moving averages but are a couple of dollars below their 52-week high of $46.69, reached in late December. The stock is fair value at the current level for investors who want some U.S. dollar assets that offer a decent dividend and longer-term growth potential.

Action now: Buy.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 2.8/5 (14 votes)

Comments

hschacht
Hschacht - 2 years ago
You don't think the "buy high quality stocks, dividend paying stocks, and utilities" is already overdone? Not exactly a new investment thesis.

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