Warren Buffett recently inked a deal to buy utility NV Energy, Inc. (NYSE:NVE) despite the utility sector’s recent pullback. That’s a huge statement about the long-term value that utilities present. Now is a good time to look at utilities like The Southern Company (NYSE:SO). and El Paso Electric Company (NYSE:EE) which operate in growing markets.
A Buffett View
Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.B) already has a material footprint in the utility sector via its MidAmerican Energy subsidiary, which serves some six million customers. The addition of NV will add more than two million additional customers to that base.
Although not exactly like a The Coca-Cola Company (NYSE:KO), utilities have some similarities to such Buffett favorites. For example, utilities have large customer bases, monopoly like powers, and electric bills are relatively small compared to the benefit of having power. Many customers don’t even look at their bills, paying them without question.
Moreover, demand is only likely to go up as we increasingly introduce electronic gadgets to make our lives better. Although population growth has slowed since the recession, any uptick would be an added tailwind.
Take the Money and Run
NV Energy, Inc. (NYSE:NVE)’s shares jumped sharply on the news of the all cash deal. Unlike regular companies, however, a utility takeover often requires the approval of regulators that can request rate concessions. So, NV Energy shareholders should probably take profits now to lock in gains and look at two other well positioned utilities to take NV Energy, Inc. (NYSE:NVE)’s place in their portfolio.
Big and Reliable
The Southern Company (NYSE:SO) serves around 4.4 million customers across four southern states. It has a small merchant power operation that is conservatively run, but it is, overall, a fairly standard regulated electric utility.
The utility operates in markets with growing populations and has good relationships with its regulators. This is a key factor supporting long-term growth. However, there are other reasons to like The Southern Company (NYSE:SO)’s prospects, including its construction of nuclear and coal gasification plants. Although these projects are large, costly, and complex, they offer many long-term benefits.
For example, upgrading infrastructure is one way for a utility to get increases in the rates it can charge customers. Both plants, meanwhile, hold the promise of allowing The Southern Company (NYSE:SO) to keep fuel costs in check, which supports profitability.
There are risks with any large projects, such as cost overruns and delays. However, The Southern Company (NYSE:SO)’s shares yield around 4.5% and the dividend has been increased annually for 12 years. That makes the shares interesting today. However, if the utility slump took the yield into the 5.5% to 6.5% range income investors should eagerly jump aboard.
Low Yield, Growing Market
El Paso Electric Company (NYSE:EE) is another boring utility that would be a decent option for profits from the NV Energy buyout. That said, it isn’t a high yield play. El Paso is more about growth.
The utility serves Texas and New Mexico, which are both growing markets. In fact, Texas boasted one of the most vibrant state economies during the recession. With the baby boomers set to retire, New Mexico and Texas are likely to see just as many people move in as NV Energy’s Nevada and Southern’s markets in Florida, Georgia, Mississippi, and Alabama.
There’s more to like, however. For example, the Fort Bliss military base has tripled in size over the past decade or so and is being considered as an Air Force training center. As the base increases in size and importance, it will draw more residents and use more electricity, boosting El Paso’s results.
Moreover, Mario Gabelli reports that “only 35% of El Paso residences have refrigerated air conditioning,” but almost all new construction includes central air. Thus, new homes being built to house new residents are going to be using more power than the current housing stock. That’s an added boost to El Paso’s growth prospects.
El Paso only recently started to pay a dividend, so it doesn’t have the impressive dividend history that Southern offers. Moreover, investors appear to be pricing in a higher growth rate. So it only yields around 3%, even after the pullback. Growth minded investors might be interested now, but yield seeking investors should probably wait for a yield in the 4% range.
Buffett Watching
Although no investor can do what Buffett does, watching his moves is pretty much an investment pastime. The purchase of NV Energy suggests that there is long-term value in the utility sector. You just need to look in the right places. El Paso and Southern are two good utilities to keep an eye on.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Southern Company.
The article Buffett Is Buying Into Utilities, Should You? originally appeared on Fool.com and is written by Reuben Brewer.
Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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