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Why Merrill Lynch Likes 5 Top Utilities, Even With Higher Interest Rates Coming

While it may seem counterintuitive to buy any stock that is considered a bond proxy in front of the Federal Reserve tightening lift-off, history shows that utility stocks tend to underperform in front of the first rate hike and sometimes outperform after. In a new research report from Merrill Lynch, that is exactly the type of scenario that they see playing out this time.

The Merrill Lynch team thinks that the Federal Reserve will raise rates in September, and Friday’s jobs report aside, others on Wall Street are warming up to a September lift-off as well. While the rate hiking may start to be consistent from meeting to meeting at the Fed, they will be small and nowhere near as fast or large as past Fed tightening. With the actual rate hikes starting and the incessant talk about it ending, a large overhang on the sector is removed.

We screened the Merrill Lynch utility stock universe and found four outstanding large-cap stocks that are rated Buy at the firm and make good sense for investors now.

American Electric Power

American Electric Power Co. Inc. (NYSE: AEP) is one of the largest electric utilities in the United States, delivering electricity to more than 5.3 million customers in 11 states. The company ranks among the nation’s largest generators of electricity, owning nearly 38,000 megawatts of generating capacity in the country. American Electric also owns the nation’s largest electricity transmission system, a more than 40,000-mile network that includes more 765 kilovolt extra-high voltage transmission lines than all other U.S. transmission systems combined.

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American Electric Power shareholders are paid a solid 3.8% dividend. The Merrill Lynch price target is $61. The Thomson/First Call consensus target is $60.67. Shares closed on Thursday at $56.26.

Dominion Resources

Dominion Resources Inc. (NYSE: D) is one of the nation’s largest producers and transporters of energy, with a portfolio of approximately 24,600 megawatts of generation and 6,455 miles of electric transmission lines. Dominion operates one of the nation’s largest natural gas storage systems, with 928 billion cubic feet of storage capacity, and it serves utility and retail energy customers in 13 states.

Dominion Resources has a series of solid growth-oriented projects in its pipeline, which include combined-cycle facilities in Brunswick County and Greensville County, Va. The company has been heavily investing in midstream assets such as Cove Point Liquefaction and Atlantic Coast Pipeline projects, which could provide solid returns for the company. The company posted solid second-quarter earnings this week, and the rest of the year should follow suit.

Dominion investors are paid a solid 3.65% dividend. The Merrill Lynch price target is $80, and the consensus target is $78.88. The stock closed Thursday at $71.33.

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Edison International

This top utility raised the quarterly dividend paid to shareholders by 17.6% last December, and another increase could be on the map for this year. Edison International (NYSE: EIX) generates electricity through hydroelectric, diesel, natural gas, gas fueled, combustion turbine, nuclear and photovoltaic sources. It supplies electricity primarily to residential, commercial, industrial, agricultural and other customers, as well as public authorities through transmission and distribution networks.

The company reported solid second-quarter 2015 results, with adjusted earnings of $1.15 per share topping the consensus estimate by 42%. The quarterly number also grew 7.4% from in the same quarter last year. Edison International posted revenue of $2.91 billion in the period.

Edison investors are paid a 2.76% dividend. The $66 Merrill Lynch price objective is less than the consensus estimate of $69.88. The stock closed Wednesday at $60.60.

PPL

This utility also beat earnings expectations but came in a little light on the revenue side. PPL Corp. (NYSE: PPL) serves 321,000 natural gas and 397,000 electric customers in Louisville and 16 surrounding counties, as well as 543,000 customers in 77 Kentucky counties and five counties in Virginia. The company also provides electric delivery services to approximately 1.4 million customers in Pennsylvania and operates electricity distribution network for the Midlands, South West, and Wales in the United Kingdom. It offers a range of customer-care and back-office services to competitive retail energy suppliers, including customer enrollments, contract management, electronic data exchange, simple and complex billing, and call center operations.

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The company is one of the leading utility companies in the United States that plans to continue to increase regulated operations and lower earnings volatility attached to competitive operations. PPL raised cash and lowered debt late last year be selling some hydroelectric assets to NorthWestern energy.

Investors receive a solid dividend that comes in at a generous 4.72%. The Merrill Lynch price target is $34, and the consensus target is a bit higher at $34.63. PPL closed Thursday at $32.09.

NextEra Energy

This company has been a very strong performer this summer and has just recently backed up some for investors to have a better shot. NextEra Energy Inc. (NYSE: NEE) is a leading clean energy company with consolidated revenues of approximately $17.0 billion, approximately 44,900 megawatts of generating capacity, which includes megawatts associated with noncontrolling interests related to NextEra Energy Partners.

The company recently completed a merger with Hawaiian Electric, which has put Hawaii on the leading edge of clean energy nationally, successfully integrating rooftop solar with 12% of its residential customers and helping meet 21% of customer electricity needs from renewable energy resources. The company supplies power to approximately 450,000 customers, or 95%, of Hawaii’s population through its electric utilities, Hawaiian Electric Company, Hawaii Electric Light Company and Maui Electric Company, and it provides a wide array of banking and other financial services to consumers and businesses through American Savings Bank, one of Hawaii’s largest financial institutions.

NextEra shareholders are paid a very solid 2.95% dividend. The Merrill Lynch price target is $120, and the consensus target is set at 117.78. Shares closed Thursday at $102.77.

It makes sense that the overhang of interest rates hikes would keep a lid on the utility sector, which is down almost 8% this year, trailing only energy. It also looks like interest rate increases are on us, and if the utility stocks can outperform between now and the end of the year, investors could be in for a nice surprise.

By Lee Jackson


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