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.

As a result of development for Ockham’s new product RazorWire, I have been watching some of the late night replays of popular business television shows.  The always entertaining Jim Cramer has a term that he uses for stocks that pay a decent dividend but because of significant price erosion now have an impressively high dividend yield.  He says that these stocks have an “accidentally high yield,” assuming the dividend is safe this is certainly a positive factor.  One stock that fits this description very well is BP (BP), formerly British Petroleum.  BP has aggressively boosted its dividends consistently for more than 10 years and has always paid a fairly generous dividend.  However, now that the stock has lost about a third of its value in the last half year, the stock is currently yielding more than 8%.

The 8% yield surely is an enticing portion of our analysis, but this high yield is only attractive if it is relatively safe.  Obviously, we will know more about this after the company reports earnings tomorrow (Tuesday) mornings, but based on the information we have as of right now we think the dividend is safe.  For starters, the dividend payout ratio (using consensus earnings estimates) will be about .37 for the year, which is not a huge concern.  The company appears to be in good shape to meet all immediate debt requirements as the quick ratio (current assets over current liabilities) is greater than 1.  Longer term debt does not seem to be of huge concern either as the company only has about $28.3 billion, which for a company with as substantial cash flow as BP is generating is understandable.  Of course, circumstances are always evolving and were the prices of oil and natural gas to fall another 30%, maybe then BP management would have to revisit the dividend issue.

BP is diversified with operations in exploration and production as well as refining and marketing.  The company has significant exposure to both crude and natural gas, with its recent acquisition of 25% of Chesapeake Energy (CHK).  No one knows for sure where the prices of these commodities is headed, but at current prices many projects have been shelved and BP has also slowed its refining capacity.  With supply contracting throughout the industry, there will be less barrels of oil and natural gas available when demand begins to accelerate once again.  These projects are far from a tap that can be turned off and on at producers will, once demand begins to take off energy prices will increase steeply as production will not be fit to meet global demand.  However, BP is increasing production and will benefit when oil prices do rebound. 

Like him or not, at least as far as BP goes Ockham agrees with Cramer on this one.  To paraphrase Cramer on this topic, from last Thursday, he believes that for natural gas BP is the preferable play to Chesapeake, as BP management has focused on improving profitability through reducing costs.  He expects to see production growth of about 6% when they report.  Furthermore, he thinks that BP will deliver higher margins and keep the “juicy” dividend.

The Ockham valuation is positive on BP as well; we currently have BP as Undervalued.  Of the major integrated oil and gas producers we have BP behind only COP in valuation, and as you can see it has performed worst in the last 13 weeks.  The stock has taken a beating along with the price of crude and gas, and now is near its lowest point in almost 6 years.  The company has historically traded for 3.7x to 5.15x cash flow over the last ten years, but the stock is currently at just 3.4x.  Furthermore, as long as you don’t think that the price of oil and gas have another 30% downside risk than the 8% yield should be enticing enough to make investors want to park some money in BP.  The upside potential of BP is great when oil and gas prices begin to ascend again.

Energy stocks have retreated quite a bit since the commodity bubble popped in mid-summer. The energy sector as a whole is down about 40% during this time frame while the S&P 500 is down a relatively moderate—in comparison—23%. Chesapeake Energy (CHK) has been particularly hammered in recent months, down a whopping 62% from its peak. Chesapeake is the nation’s largest natural gas producer and its stock has suffered from plunging gas prices as well as a debt load that is worrisome in this credit environment. There was also the embarrassing news story of the company’s CEO receiving a margin call as a result of the stock’s decline. Well, Chesapeake reported earnings yesterday and while the earnings were nothing spectacular they do give additional insights into the health of the company.

Chesapeake reported earnings of $.85 per share, excluding one-time events, which missed consensus estimates by 3.4%. Chesapeake had beaten estimates for the previous 3 quarters. However, the company had hedged pretty effectively against the falling price of natural gas and oil during the quarter which amounted to a gain of $2.8 billion and when you incorporate those profits into the results the company earned $5.61 per share. Clearly, there is a reason that analysts do not account for “one-time” events but it is certainly worth noting when there is such a huge difference. CHK hedged by securing higher prices in the past for delivery in the future, which could have come back to bite them had prices risen. Also in response to the lower price of natural gas Chesapeake has chosen to slow its production. During the past quarter, production fell .3% from the prior quarter and 15% from one year ago. This is a logical response to low prices and with demand for gas likely on the rise with high profile energy independence plans such as the “Pickens Plan” getting a lot of attention, odds are the price of natural gas will rebound.

Chesapeake stock has had an especially painful run of late because the company does have a substantial debt burden. The total liabilities have declined in the most recent quarter and total assets have increased. The ratio of total debt over total assets has fallen from 73% in the previous quarter to 59% in the quarter just ended. While 59% is still a large debt burden in such environment, the company is clearing enough cash right now to easily service this debt. Furthermore, the company has no senior notes maturing before 2013. In Chesapeake’s business, debt is inescapable as drilling requires substantial initial costs, and interestingly, the company’s asset-to-equity ratio of 2.44 is actually below its historical average of 3.1. It seems to me that CHK is generating enough cash to continue to reduce its debt exposure and, were the credit situation in the macro-economy to improve, CHK’s debt burden would seem pretty benign.

The assets Chesapeake owns undoubtedly have substantial value, and some particularly important assets are portions of the Marcellus Shale a huge natural gas field in the Appalachian Basin. Preliminary estimates are that this field holds up to 1.9 trillion cubic feet of gas (according to a 2002 U.S. Geological Survey), although these reserves are spread out over a massive area. Chesapeake, in its Oct. 19^th conference call, estimated that its interests in the Marcellus Shale to be worth about $13.5 billion. That’s not too bad for a company with a market capitalization of about $12.5 billion. No wonder Chesapeake has considered selling some of these assets to the likes of BP (BP).

The fact of the matter is that Chesapeake calmed investors in with its recent quarter’s results. Yes the company has debt, but it is shrinking and not due for some time. Management effectively handled the eroding price of gas by hedging a significant portion of its production at higher prices. CHK has assets that, according to their own estimates, are worth more than the entire companies stock, so book value per share in theory exceeds the share price. Both price-to-cash flow and price-to-sales are significantly below their 10 year historical averages. So, although there are a lot of value plays in this market for patient investors, Chesapeake could be one of the best.

Nicor, Inc. (GAS) has been downgraded to Sell by Ockham Research because it appreciated so much over the summer that we now view it as overvalued and vulnerable to a correction, particularly if commodity prices continue to slide. Nicor is a holding company for a natural gas distribution business serving 2.2 million customers in Northern Illinois. As a regulated company, Nicor must gain the approval of the Illinois Commerce Commission in order to increase the rates it charges customers. Over the past few months, gas prices have increased dramatically, which has caused the company to seek rate relief so as to pass some of its increased costs onto to end users.

Based on Ockham’s valuation methodology, GAS shares are gassed right now and ripe for a pull-back. The weighted average historical Price-to-Sales ratio range over the last ten years has been .52x - .75x, while the stock’s current Price-to-Sales ratio is .59x, which is below its historical weighted average by seven percent. This level merits a neutral stance from Ockham. However, the GAS’s Price-to-Cash Flow number is a different story. Its historic range is 5.10x-7.18x and GAS’s current Price-to-Cash Flow metric is 7.43x—well over the upper end of that range. Therefore, the stock is well over glide slope according to our methodology and merits the Sell rating.

While Nicor’s high dividend yield (nearly 4%) and .90 Beta (lower than average volatility) probably appeal to weary investors at the present time, the stock is over bought at present. Ockham placed a Buy on the stock when it hit $32.95 in March. However, in the upper forties, the stock no longer meets our stringent valuation criteria and would be a source of funds for repositioning money into oversold alternatives.

Also, as Nicor’s customers become more conservation conscious given the tough overall economy and rapid rise in the price of gas, earnings could come under pressure for the next few quarters. Also, the pending rate case could end unfavorably for GAS, further impacting earnings. A pullback in price would certainly make us more bullish on these shares. Until such time, we recommend that investors keep their eyes open for better buying opportunities on undervalued stocks.