If you think the shares of electric and gas utilities are boring issues best purchased for their yields, Ron Saba has a surprise for you. A portfolio manager at San Diego-based Brandes Investment Partners, Saba thinks utilities offer some of the hottest growth prospects on earth. But not just any utilities. With concerns over rising U.S. interest rates helping to push the Standard & Poor's Utility Index down 15% since fall, Saba has been buying utility issues from Austria, Britain, and Spain.
It's not hard to see why Saba is looking abroad. While analysts expect U.S. utilities' profits to expand by a meager 3% or less this year, many overseas electric and gas companies could see their earnings jump by 20% or more. In Europe, utility profits are being buoyed by spreading deregulation, massive corporate cost-cutting, and the stirrings of an economic recovery. Plus, privatizations and surging demand for electricity are yielding a bonanza for utilities in Latin America and Asia.
CHALLENGES. And you don't even have to venture overseas to get in on the power plays. Many of these utilities issues trade in dollars as American depositary receipts (ADRs). What's more, several leading money managers, including Franklin/Templeton Group, Prudential Securities, and Merrill Lynch, offer global utility funds.
Investing in international utilities poses some special challenges. Dividends on many issues tend to be small. It can be tough to interpret the policies of industry regulators thousands of miles away. And the dollar value of stock in European and Japanese utilities could take a hit if the yen and the mark decline later this year, as some traders expect. But investment pros say such risks are worth taking, given the long-term growth outlook abroad. Indeed, many big domestic utility funds are venturing overseas. Prudential Utility Fund now has $1 billion--or about 20% of its assets--invested outside the U.S.
About $600 million of that is in Europe, where Warren Spitz, managing director of Prudential Investment Advisers, is especially fond of a company many others are shunning--British Gas. Facing the loss of its monopoly on retail sales in 1996, the utility on Feb. 24 took a big $2.45 billion write-off that sent its ADRs plunging $2 apiece. But that may present a buying opportunity. In addition to its tempting 5.2% yield, the company owns rich oil-and-gas tracts that may be spun off to investors someday. At $49, "the stock is probably 40% to 50% undervalued," Spitz says.
Money manager Saba makes much the same case for another British utility, Norweb. A distributor of electricity to Britain's northwest, Norweb has been on a cost-cutting mission since its privatization in 1990. Profits soared 23% in the first fiscal half, ended last Sept. 30, and Norweb now boasts a return on equity of 20, double that of many U.S. power companies. Yet Norweb's ADRs hardly reflect its successes. Now around $32, they trade at 11 times earnings, against 19 for the S&P utilities on average.
But some analysts argue that even better values lie in the emerging economies of the southern hemisphere. Simon Goodfellow of London's Baring Securities notes that Latin American electricity demand is rising by nearly 5% a year, vs. just 1% for North America. That's one reason why Templeton Global Utilities Fund has "expanded rather strongly" in the region lately, says portfolio manager Harry Ehrlich. He likes Chilectra, a privatized Chilean power generator with over-the-counter ADRs. Other pros favor Bolivian Power, on the New York Stock Exchange. Analysts think its earnings will climb 15% annually over the next five years. Putnam Utilities Growth & Income Fund recently snapped up 220,000 of its shares.
BONUS. Many pros also recommend China Light & Power, a big Hong Kong utility. Merrill Lynch analyst Alice Hui thinks CLP's earnings could jump 70% this year. It is expected to turn a $1 billion profit by redeveloping an old Hong Kong power-plant site for residential and business use. That would be a "handsome bonus" on top of generous revenues expected in coming years from power plants the company is building in China.
In the emerging and industrial economies, such growth stories are becoming more prevalent. "Utilities are a vital part of your portfolio," says Baring analyst Goodfellow. Especially if they have a foreign accent.