Sector Profit Alert: Utilities

June 25, 2009

Dear Fellow Investor,

We got off to a great start last week with our first installment of Sector Profit Alert. Two of the three stocks I called out as “Strong Buys” have put up very impressive gains in just a week’s time. It looks like Lancaster Colony (LANC) is going to need a little more time to gather its momentum, but with the stock ranked as an A in Portfolio Grader and the consumer staples sector heating up, I don’t think it’ll be long before we count LANC among our winners. And considering the S&P has lost more than 3% since I made these recommendations, there’s no doubt that these picks are clearly outperforming the broader market.

COMPANY	SECTOR	SINCE 6/18
Coffee Holding Co. (JVA)	Consumer Staples	17%
Lancaster Colony (LANC)	Consumer Staples	-2.3%
Orchid Paper (TIS)	Consumer Staples	10.5%

When we covered Consumer Staples stocks last week, we talked a lot about how even in the darkest economic environments consumers have to buy food and other essential items. This is why consumer staples stocks are such a good bet right now and where you should look first if you’re ready to add to your portfolio.

While consumer staples has been chugging along nicely in this market, there are other sectors that have taken a beating. The obvious lesson you can take from such a sector is that these are stocks you should avoid—but it’s important to note that sectors which have fallen out of favor now may very well be the new market leaders in just a short while.

Everyone wants to own the next comeback stock—after all, the idea is to “buy low and sell high,” and finding a stock that has been unfairly knocked down and is ready for a triumphant return is a proven way to make big profits.

I have a few of those big comeback stocks for you today in today’s Sector Profit Alert.

Sector Profit Alert: Utilities

The utilities sector has taken a beating lately, in large part to lingering uncertainty over the Obama administration’s plan to limit carbon emissions through a program called “cap and trade.” Essentially, this program would require high-emission businesses to purchase carbon credits from cleaner companies that come in under pollution limits. The idea is to make it profitable to go green because clean businesses can sell their emission credits and dirty businesses have to pay more as they pollute more.

In theory, this scheme works well. However, the reality is that power plants tend to be the highest carbon emitters—and that means utility companies would pay a lot more to generate electricity under a “cap and trade” plan. That’s a big problem, since it is extremely difficult for utilities to pass that expense on to consumers and businesses. Manufacturers need cheap electricity to stay profitable, and regular Americans will be outraged if their monthly energy bills go up significantly during a recession. There are many proposals out there to mitigate the damage, but the bottom line is that this scheme is going to put pressure on the utilities sector.

This dark cloud of uncertainty regarding cap and trade has weighed on utility stocks. In fact, out of about 120 or so utility companies that are ranked in my exclusive Portfolio Grader database, only 12 of them qualified as A-grade stocks and received my highest “Strong Buy” rating.  So in general, I’m telling investors like you to steer clear of utilities.

But just because 90% of these stocks don’t make the grade doesn’t mean you can’t find some big winners. Let me point out a few:

A Bright Spot for Utilities

Utility stocks come in a number of different flavors. There are water companies, electric companies, gas companies and companies that do a little of everything. And right now, the Gas Utilities industry is doing much better than any other slice of this sector. Here’s why:

First off, natural gas is the cleanest-burning fossil fuel. If and when cap and trade is implemented, any gas utility will be at an advantage simply because of lower emissions.

Second of all, natural gas prices are incredibly low right now. Potential U.S. natural gas reserves are estimated at 40% more than they were last year due to technology improvements, and natural gas prices have declined 27% so far this year alone. Since gas utilities only adjust their prices at regularly scheduled Public Utilities Commission meetings, lower gas prices work in their favor. They can continue charging the same rate for a product that is now costing them less to deliver.

Lastly, natural gas like all commodities is driven by a simple supply and demand equation. High summer temperatures increase electricity demand for air-conditioning, and natural gas power plants help fuel manufacturers and other businesses, so there is a good chance that as the economy starts to turn around later this summer that these gas utilities will turn around sharply, too.

Again, I must stress that most utilities are looking bad right now. But I have a couple top-rated gas utilities that are flying high and should be the breakout winners of the otherwise gloomy utilities sector.

NEXT UP: Utilities stocks to buy and sell!