By Sam Stovall Several weeks ago, while I was flipping through my 52-week relative-strength charts of sectors and subindustry indexes in the S&P Composite 1500 (S&P's total U.S. stock universe) -- as I usually do when in search of a sector story -- I came across a chart on the S&P Water Utilities subindustry index. The industry's price momentum looked constructive to me. And a few weeks later, that group officially joined S&P's high-momentum list.
Is another utility group ready to make the same move? I was doing the same kind of chart trawling in early June and stumbled across the S&P Gas Utilities subindex, which also looked promising. (Its chart is pictured below. The jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindex's 14-year mean relative strength.)
STALLED IN NEUTRAL. This subindex consists of 20 companies. During 2004, it advanced 12.5%, a shade better than the S&P 1500's 10% advance. This year, the group is up 5.7%, vs. the S&P 1500's decline of 1.1%. But will shares of gas utilities continue their steady performance? And should investors take a closer look?
Well, it seems the group's hottest days may be behind it. S&P equity analyst Yogeesh Wagle says S&P's fundamental outlook for natural gas utilities is neutral. S&P believes gas utilities -- characterized by slower growth but higher dividend yields -- have enjoyed above-average returns vs. the S&P 1500 due in part to historically low interest rates, which have made their dividends more attractive to investors. A lower tax rate on dividend income, enacted in 2003, has also increased the appeal of these traditionally high-yielding equities.
For 2005, Wagle expects mid-single-digit growth, on average, for regulated utility operations. Rising insurance and labor expenses, higher bad-debt costs, and a difficult regulatory environment for utility-rate relief should mostly offset gains from customer growth and economic expansion.
"ROBUST GROWTH." With ratepayers already ponying up more for natural gas supplies (via provisions that allow utilities to pass along higher gas costs to customers), S&P believes utilities face an uphill battle in securing rate increases. Rising prices should lead to lower usage per customer, particularly from industrial customers with dual-fuel operations, in our view. Wagle thinks gas utilities will see a slowdown in customers switching from oil to gas in reaction to high commodity prices.
Over the next two to three years, Wagle will be looking for gas utilities with earnings growth below that of the S&P 1500. S&P also sees investment risks associated with a recovery in the economy, which we think will lead to higher interest rates over the next couple of years, making these shares somewhat less attractive on a yield basis.
On the other hand, the analyst has a favorable outlook for natural gas distribution companies with exploration and production (E&P) operations. These companies, in S&P's view, should see robust earnings growth driven by higher gas prices and a favorable regulatory environment that will likely increase access to public lands for drilling and pipeline expansion, and expedite permit procedures.
CAN'T HAVE IT ALL. Gas utilities with E&P operations should be able to ramp up production to capitalize on high prices. Wagle also sees utilities with gas-gathering, gas-processing, and unregulated pipeline operations benefiting from strength in gas pricing.
To sum up: In S&P's view, the subindustry's momentum looks favorable, but the fundamentals don't support an aggressive stance in the coming year. Oh well, you can't win them all. But some individual stocks in the group are worth considering, according to S&P. While S&P analysts don't rank any companies in the group 5 STARS (strong buy), two carry 4-STARS (buy) recommendations: AGL Resources (ATG
; recent price, $36) and ONEOK (OKE
Source: Standard & Poor's
Industry Momentum List Update
For regular readers of the Sector Watch column, here's this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), and their proxies (the highest STARS-ranked companies in the subindustry index -- tie goes to the largest market value) as of June 3, 2005.
S&P High Momentum Portfolio -- 5/27/05
S&P STARS Rank
Diversified Metals & Mining
Fertilizers & Agr. Chem.
Managed Health Care
Oil & Gas Drilling
Oil & Gas E&P
Oil & Gas Refg. & Mktg.
S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.
S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:
S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.
S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.
S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.
Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.
In the U.S.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.8% of issuers with buy recommendations, 56.7% with hold recommendations and 12.5% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 29.2% of issuers with buy recommendations, 50.5% with hold recommendations and 20.3% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 34.3% of issuers with buy recommendations, 48.0% with hold recommendations and 17.7% with sell recommendations.
As of March 31, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.2% with hold recommendations and 13.8% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.
For All Regions:
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
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Readers should note that opinions derived from technical analysis might differ from those of Standard & Poor's fundamental recommendations. Stovall is chief investment strategist for Standard & Poor's