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2 Top Hybrid Electric Utilities to Buy

February 23, 2011 – by Richard Band

I recently discussed a bargain utility stock I liked, and today I’d like to share a few thoughts on “hybrid” (generation plus distribution) electric utilities.

But first, some market news. The U.S. stock market has defied gravity for weeks. But finally, in Tuesday’s session, soaring oil prices got investors’ attention. With the price of crude surging as high as $95 a barrel (thanks to a partial shutdown of production in strife-torn Libya), the Dow gave up 178 points at the close.

Percentagewise, other indexes suffered even bigger losses. The Nasdaq, for example, fell the equivalent of 339 Dow points.

Let’s keep things in perspective, however. This setback was trivial compared with the market’s race up the flagpole since last summer.

A modest retrenchment now would be normal and healthy, bringing share prices into closer alignment with the improving economic fundamentals. And the fundamentals are improving, as we saw yesterday from the encouraging report on February consumer confidence (up 5 points to the highest reading since February 2008).

So what looks good to buy now?

Top Hybrid Utility Stocks to Buy

The hybrids’ business model gives them the potential to earn higher profits than fully regulated utilities do. That’s because the hybrids typically sell power from their generating plants to the highest bidder. When electricity demand is high, the hybrids can charge more.

Of course, the opposite is true when power usage slumps. Of late, prices for electricity to be delivered in 2012 and 2013 (futures prices) have languished well below the peaks reached in 2007 and 2008. Accordingly, skeptical investors have marked down the share prices of most hybrid utilities.

There’s a decent chance, I believe, that the ongoing economic upswing will lift wholesale power prices as we move into the second half of 2011. That would relieve some of the earnings pressure that Wall Street expects to weigh on the hybrids this year and next.

Even if power prices remain subdued, though, I’m confident that hybrid utilities Entergy (NYSE: ETR), Exelon (NYSE: EXC), NextEra Energy (NYSE: NEE) and Public Service Enterprise (NYSE: PEG) will keep paying dividends at the current rate.

Of the quartet, Florida-based NEE boasts the strongest growth outlook over the next two or three years. Thus, I would make NEE my No. 1 buy for new money on a pullback to $53 or less.

ETR is OK to buy even now for its ample 4.6% yield, but I would caution that the board of directors could decide to skip a dividend increase this year if power prices stay in the doldrums. Pay up to $73 for ETR.