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The utilities outlook for 2013

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Amid a very positive year for the Standard & Poor’s 500 index — which rose as a whole by more than 13 percent — 2012’s one set of losers was the utilities sector. It was the only one of the ten sectors that make up the S&P that actually lost ground last year, falling in value overall by 3.5 percent.

But 2013 could be very different for the utilities. While there are legitimate reasons to be wary of it in the immediate future, there are also several factors that argue for a strong bounce back for the sector.

Perhaps the most obvious one is simple reversion to the mean. Back in 2011, the worst-performing sector was the materials, which dropped by 2.2 percent. But in 2012, materials returned 23.4 percent. In 2011, the financial sector was among the weakest performers, beating out only materials; in 2012, it was the best-performing sector, returning a whopping 25 percent.

So there’s a history of sectors bouncing back. The utilities sector, meanwhile, is usually a solid performer. Counting dividends, it returned 12.7 percent in 2011 and 13.7 percent in 2010. The sector is just as likely to return to those levels in 2013 as to repeat 2012’s disappointing performance.

The sector could also get a pop from the rules regarding dividends. Utilities are famously dividend-heavy stocks, and one of the automatic results of going over the fiscal cliff would have been a steep hike in dividend taxes: Had Congress failed to take action at the end of the year, dividends would have been taxed in 2013 as ordinary income, which for the top tax bracket would have meant a healthy 39.6 percent, up from the previous rate of 15 percent. The market had pretty clearly priced that potential change into the valuation of dividend stocks.

But in the end, the tax rates on everyone’s dividends didn’t triple. The rate increased only for people in the top tax bracket, now defined as $400,000 in income for individual filers and $450,000 in income for married couples. And even for them, the rate for those people only nudged up from 15 percent to 20 percent.

So the beatdown that was expected to inflict itself on dividend stocks has not come to pass. Suddenly, the average dividend yield of 4.1 percent on utilities stocks looks very attractive. That’s roughly double the average dividend yield for the S&P 500 at 2.07 percent, and more than twice as much as the yield on the U.S. Treasury ten-year bond.

What does the business landscape look like for utilities? Power prices, which have been an issue for the industry, appear to be stabilizing for 2013. But there are headwinds as well, beginning with the need to rebuild infrastructure systems. According to an estimate from the National Association of Regulatory Utility Commissioners, the cost of upgrading our water, natural gas and electric systems could exceed $4 trillion over the next 20 years.

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There are some very interesting names in the sector. If you’re interested in playing a rebound, Exelon (EXC) was one of the bottom ten performers in the entire S&P 500 in 2012, decreasing in value by nearly 30 percent. In large part as a result of that decline, Exelon’s price-to-book value is a skinny 1.17. Its annual revenues, $21.4 billion, aren’t far off from its market cap of just over $25 billion. Exelon, a diversified utilities company based in Chicago, also exemplifies the upside of the utilities sector: Its dividend yield is a sizable 7.06 percent.

If you’re looking for stocks that showed strength even as the sector has sagged lately, there are a couple of very strong ones to consider. Cleco Corporation (CNL), a utility holding company in Louisiana, was up more than 10 percent last year and up 47 percent over the past five years. Wisconsin Energy Corp (WEC), an electric utility based in Milwaukee, was up around 9 percent in 2012, and has risen by 57 percent over the past five years.

And they provide a certain amount of downside protection. Even if the economy falters next year and people decide not to visit Disney World or buy a new car, they still won’t stop buying water or electricity.

For more from Tom Nawrocki, see:

6 market predictions for 2013

The Russell 3000: Biggest losers in 2012

Top 10 stocks in 2012