Vectren (VVC) is probably not a household name, unless of course you live in Indiana or Ohio and they provide your gas or electricity.  With that said, we think that investors may want to familiarize themselves with this company as it is the most attractively priced utility out of the 118 utility stocks we cover.  For starters, Vectren is an energy holding company for three public regulated utilities operations: Indiana Gas, Southern Indiana Gas and Electric (SIGECO), and the Ohio operations. 

Realistically, Vectren’s business can be broken down to simply Gas and Electricity services.  The natural gas segment accounts for over half of the company’s sales, but less than a third of their net income because they make a smaller spread on supplying gas.  The electric utility is just over one-fifth of the company’s revenue but provides about 40% of net income.  One of  the main reasons for Vectren’s profitability in electricity is because they supply the vast majority of the coal used in producing electricity from their own mines.  In general, producing the coal instead of buying it from a third-party (like gas) leads to greater cost savings and higher profitability.

In terms of Vectren’s valuation, we compare the company’s current valuation versus how the market has valued it in the past.  So, over the last ten years the market has been willing to pay .89x to 1.16x times revenue per share, but the current price-to-sales level is below that range at .83x.  Furthermore, price-to-cash earnings is currently only 3.6x, but the market has historically ranged all the way from 6.1x to 8x.  Clearly, this stock has fallen out of favor with the market for any number of reasons, but with a 6% yield investors can afford to wait for its perception to change.  Based on the current fundamentals, if the stock were to reach just the lower end of those ranges, it would imply a price of around $34 per share or 50% higher than today’s close.

Of course, as with any stock investment, there are risks.  Being a regulated utility means that Vectren has little to no control over their pricing, as it is mandated by the state.  If the state came down hard on utilities, Vectren would have little recourse and profits would suffer.  Also, there is no potential for rapid growth for a regulated utility, aside from a major ramp up in power usage within their covered area.  However, those are always the drawbacks involved with a utility stock, but we think at these valuations there is enough appreciation potential to attract investors.

For investors worried about the near term future of the stock market, this may be a decent defensive option with a beta coefficient of only 0.39.  Furthermore, the yield which has been steadily rising also offers some protection for investors.  With limited downside risk and a valuation that suggests plenty of upside, we think long term value investors should begin to familiarize themselves with Vectren.

“I also want to show you UTX, United Technologies because its board of directors just approved a 10.4% increase in its first quarter dividend to 43 cents a share.” — Fox Business Network 2/8/2010

Dividend investors continue to delight in the shareholder-friendly actions of United Technologies’ (UTX) board, as they have increased the dividend from $.39 to $.43.  The change will become effective as of their first quarter payout in March for shareholders of record on Feb 19th.  Despite the nearly 20% drop in earnings per share results for the full year from 2008 to 2009, they maintained the impressive streak of almost yearly dividend increases. We would expect UTX to raise dividends in-line with earnings growth into the future.  With consensus analysts’ estimates calling for EPS growth of 12% in fiscal 2010 and 14% in fiscal 2011, future dividend raises could be significant.

United Technologies has avoided much of the difficulty that have befallen competitor and fellow Dow component General Electric (GE) due to their highly leveraged financial unit.  Instead, United Technologies who does not have a finance unit has worked diligently on their core products making everything from elevators to jet engines to air conditioners. This focus on its traditional business lines has proved a wise move and allowed UTX to greatly outperform GE over the long term.  For example, over the past ten years UTX stock is up 157% versus a 67% decline for GE.  This outperformance is also evident in dividend payout history as well; remember, last year GE slashed its dividend by 68% in order to conserve cash.

The dividend announcement from United Technologies makes us view the stock more positively, but we are content to leave our neutral or Fairly Valued rating on UTX at this point.  The company has been much less affected by the credit crisis than GE, but it is not immune to a weak economy as sales and earnings have both declined over the past year.  These fundamental factors are showing steady improvement, but we think the price adequately reflects this improvement.  For example, historically speaking UTX has normal traded between .97x to 1.45x times revenue per share and the current price-to-sales is near the middle of that range at 1.18x.  Similarly, their price-to-cash earnings have historically ranged between 9.8x and 14.7x, and the current level is 11.7x.

We view the current valuation of UTX to be in-line with what we think is justified by the fundamentals.  However, as today’s announcement demonstrates, this is a great stock for income-oriented investors.

The price-to-peak earnings multiple declined slightly to 11.9x as of last week’s close.  On Friday, the market recovered from deep losses with a late-day rally that brought the DJIA back over the 10,000 threshold.  For the week, the broad market indices fell between .5% and 1% with the S&P 500 now about 7.5% below its recent high.

In general, earnings reports have come in better than expected, but this has failed to boost market valuations.  Companies are beating analysts’ EPS estimates about three-quarters of the time, but top line growth has proven to be more elusive.  The bull market began about 11 months ago, and a large amount of the earnings improvement has been priced in to stocks.  Under normal conditions, we consider a price-to-peak earnings multiple under 12x to be a bullish signal; however, this time, the reality is that earnings–while much improved over the past year–are still down 60% from their peak.  Thus, we remain cautious regarding the market’s valuation even as fundamentals improve.

The percentage of NYSE stocks selling above their 30-week moving average has fallen for the fourth straight week to 51%.  Investor sentiment has normalized after months of extremely bullish readings.  A degree of uncertainty has crept back into the market as investors fear more sovereign debt problems out of highly-leveraged European governments.  This has strengthened the dollar, but augers that the global economic recovery will be strained.  On Friday, Moody’s warned of a possible downgrade of the U.S. debt rating unless spending is restrained.  Economists have warned that soaring spending on entitlement programs will eventually become a problem, but according to Moody’s, this issue cannot be ignored much longer.  Public debt issues at home and abroad, along with a persistently weak labor market have stock investors in the mood to take profits.

We remain defensive towards the market as sentiment has quickly retreated, reflecting growing worry and a refocus on risk.  For the majority of the last year, the market rallied on the belief that, although fundamentals were not particularly strong, better days were surely ahead.  However, a weak employment market underlies a potentially slow and grinding recovery rather than the typical post-recession rebound.  In addition, the government is planning to exit from many of the programs that have propped up the economy.  With the economy needing to stand on its own two feet, 2010 could be a much less favorable year for equity investors.

Barrick Gold (ABX) has made a number of bold moves in the past year in order to take advantage of all time high gold prices.  In early September, as gold was crossing the $1000 per ounce level, Barrick Gold announced that it would issue a secondary offering in order to raise capital and buy themselves out of some bad hedging bets from prior years (Barrick’s Secondary Offering to Buy Them Out of Bad Hedging).  It was clear that they had hedged their industry leading production to a price level that was far below the current market value.  It was at that point that they developed a plan to undergo the expensive processes of buying out their hedges.

The price continued to climb after the announcement by nearly 20% over the next three months.  In December, Barrick’s hand was forced as every gain in gold prices made their hedges more expensive to buy out.  They had planned to phase out of their hedges over a period of 12 months, but on December 1st, with the price of gold above $1200, they simply could not wait any longer and risk further liability from rising prices (Barrick Gold Races Out of Hedges).  The company paid $5.1 billion to neutralize their horrendous hedging decisions and 80% of their floating contracts as well, and the average price per ounce was $1070.

Well, the announcement of paying off their hedging came just about at the top of gold’s run, and since the beginning of December gold prices have fallen about 10%.  ABX stock which is clearly affected by the price of gold has fallen by 16% in that period (even though it was up 5% on Friday).  With that said, the company is still getting much more benefit out of each ounce of gold it produces, and it is growing production rapidly.  Barrick has estimated it produced about 7.2 to 7.6 million ounces in 2009 at a cost of about $450 to $475 per.  They anticipate growing production by nearly 7% in 2010 as well. 

At Ockham, we have a Fairly Valued rating on ABX as of this week’s report, and will likely maintain that rating in the upcoming report.  We will get a better idea of their production and financial position when they report earnings on Febuary 18th, but it is clear that they should focus on growing production and lowering costs because their past performance as a “commodity trader” have been horrendous.  You would expect no one has a better grip on gold prices than the world’s largest producer, but apparently not in this case.

Bloomberg.com is running a story about an underreported potential windfall for the nation’s largest drug store chains Walgreen (WAG) and CVS Caremark (CVS).  The reason for the optimism is the end of patent protection for the world’s two best selling drugs Lipitor and Plavix.  Soon after blockbuster drugs lose patent protection is a very profitable time for drug stores as they have more control over pricing, and even though generic drugs are cheaper than branded drugs, they generally provide better profit margins for the pharmacies.  According to the article, pharmacies pay 90% less for the generics, but do not pass all of those savings on to end consumers.

Bigger and Longer

The last large wave of patent expirations came in 2006 and 2007, when branded drugs generating sales of $43 billion faced generic competition, according to Norwalk, Connecticut-based IMS Health Inc., a market research firm. That helped boost CVS earnings per share by 20 percent in 2007 and Walgreen’s by 19 percent in the fiscal year  that ended in August 2007.

“This cycle is bigger and it’s longer” than the introduction of generic drugs in 2006 and 2007, Taner, the Invesco fund manager, said in an interview. Invesco increased its holdings to 5.68 million Walgreen shares and 5.96 million CVS shares as of Sept. 30, according to Bloomberg data.

CVS and Walgreen will also benefit because they have expanded in recent years, gaining pricing power, said Massey, the SunAmerica investor. Still, prices pharmacies pay for drugs won’t drop as much in the next cycle because there are fewer manufacturers as a result of mergers. — Bloomberg.com 2/5/2010

Current analysts’ estimates call for CVS to grow earnings by 11% in 2011 and 14% in 2012, and Walgreen is expected to grow at 17% in both years.  However, judging by the explosive earnings growth of the last major wave of generics, even those impressive estimates may be too tame.  All other things being equal, earnings growth of this magnitude would surely  drive both stocks higher.

Generic alternatives for Lipitor and Plavix will not be available and therefore accretive to earnings until early 2012 at the earliest.  Even at current estimates for forward-looking earnings, we think both of these stocks are Undervalued at the current price level.  We selected WAG as one of our Five Blue Chips Fit For Ben Graham when asked to do a special report for Forbes.com early last September, and the stock’s price is at about the same as it was then.  At that time, we were not aware that the new wave of generic drugs was as promising as it appears to be, and we continue to believe that both of these stocks have substantial value to investors.  Both stocks have sold off heavily in the past three trading sessions which generally makes these stocks even more attractive to long term, value investors.