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By Josh Peters, CFA | 10-19-2010 04:52 PM

Need Yield? Check Out Utilities

Morningstar's Josh Peters and Travis Miller examine why utilities stocks look attractive for dividend investors today.

Josh Peters: Hello, I am Josh Peters Editor of Morningstar DividendInvestor. If you've been looking at the markets lately you might see that utilities have been running kind of hot. Why don't we take a little opportunity to shed some light on the subject. Here with me today is Morningstar's senior utilities analyst, Travis Miller.

Travis Miller: Hi, Josh.

Peters: Hi, Travis. How was that for the bad pun of the year award?

Miller: Yeah, we do think there are some attractive opportunities in utilities right now. Especially for income investors. If you look at the spreads right now between dividend yields, about 4.5% right now across the regulated utility industry and you look at where interest rates are these days. So, look at the 10-year, the 30-year Treasury. The spreads are at historic highs, almost 200 bps on the 10 year treasury.

So, we think if you're looking at relative yield plays that utilities still are a good place to go.

Peters: Well, obviously the relative yield spread is very interesting, but what about absolute returns. If we are looking at dividend yields for utilities relative to long-term treasury yields might now we just be seeing the idea that treasuries are overvalued and under yielding?

Miller: Yeah, that's certainly possible. But we want to look for in a good high yielding utility is the opportunity for growth investment. So, the utilities that we like right now are the ones that don't depend on inflation, they don't depend on the economy to rebound. Utilities that have projects that are economically insensitive. Projects such as environmental, capital expenditures such as infrastructure rebuilding that don't need an economic rebound to produce growth for dividend investors.

Peters: What's your favorite example of this phenomenon?

Miller: We like Westar, ticker WR, right now is one of our best picks. It's a Kansas-based utility. Couple of things that we like about them, one, if we go back to growth projects that don't need an economic rebound, Westar has about 90% of its generation from coal-fired power plants. Given the environmental regulations that are coming out, even excluding carbon regulations, they're going to have to put billions of dollars in capital into those coal plants to clean up all of the noncarbon emission; sulfur dioxide, nitrous oxide.

Kansas also as everyone knows is the Saudi Arabia of wind. So, as other utilities build wind projects in Kansas the transmission lines to get that power from the middle of Kansas to demand centers are very high return types of projects for Westar. Should produce 6%-8% dividend growth and earnings growth we think.

Peters: Well, I do have to ask you about the environmental capital expenditures. I mean, doesn't that sound like they are just going to pour a lot more money into just stay where they are at already?

Miller: Well, yes, they do need to upgrade those plants to keep that generation available for the customers. But there are also high return projects for the utility and shareholder investors.

Peters: Also they are allowed to earn a return on those investments?

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