The One Place Value Investors Forgot to Look

Sometimes the market drops the ball.

That’s when value investors strike.

In this case, investors should look into one area the market left behind in the rally: Utilities. Many of these companies were beat up during the selloff, but because of plummeting natural-gas prices, they didn’t participate in the rally.

Natural gas is the country’s second-largest fuel source for power generation. The bottom fell out of the natural-gas market more than a year ago, and electricity prices sank with it. The industry built a significant amount of storage capacity as inventories increased +15% higher than the five-year average, according to the Energy Information Administration.

Until winter comes and people turn their heaters on, supplies will remain high. That shouldn’t last for long, especially as winter is approaching the northern part of the country.

Some utilities still trade at the same levels they did in March, even after a rally of more than +60% in the S&P 500. The market downturn combined with falling natural-gas prices created the perfect storm, and some utilities were left for dead.

The assets of these companies can still be had for embarrassingly cheap prices.

Company Recent Price Yield P/E P/B
NiSource (NYSE: NI) $13.36 6.7% 11.3 0.77
Pepco Holdings (NYSE: POM) $14.75 7.1% 12.3 0.79
Ameren (NYSE: AEE) $25.20 6.0% 9.4 0.76
Dynegy (NYSE: DYN) $2.24 N/A N/A 0.50

These companies are trading at steep discounts to their asset values, shown by the price-to-book value (P/B) measurement. You can calculate book value by subtracting liabilities from assets on a company’s balance sheet and dividing that number by the number of shares outstanding. This figure is known as per-share book value. To see what the market is paying for those assets, divide the company’s share price by the book value per share. Anything over 1.0 is the market’s value of the company’s underlying business.

But the market isn’t even paying full price for the assets of these utilities. They are paying less for the company that the net value of its transmission pipelines, power-generating equipment and other tangible property. Three out of the four companies in the table are profitable, but the market is paying nothing for those profitable businesses. Even with the headwinds facing utilities, that’s hard to believe.

And it’s not likely to last long.

These companies are a safer way to play natural gas than buying natural gas futures with troublesome funds like the U.S. Natural Gas Fund (NYSE: UNG), which trades for a +4% premium. But they’re also value plays, trading for discounts of -20% or more.

The best part about this sector: Generous dividends. So while investors wait for a recovery in prices, they can collect a fat quarterly check in the meantime.

This year, the Natural Gas Supply Association expects demand to be flat compared with last year, but there are a few wild cards at play. Forecasts suggest a slightly warmer winter for some part of the country, but that could be offset by a much colder winter in the Northeast. Economic conditions also could improve and cause an uptrend in prices. This could have even more of an impact on prices than the weather.

The best pick in the table above is NiSource (NYSE: NI), a holding company that stores and distributes natural gas from the Gulf Coast to the Northeastern corridor. Its 3.8 million customers make it the best positioned utility to benefit from a cold winter in the Northeast.

NiSource’s shares are up +35% for the year, but still trade at a -20% discount to book value — while paying a generous 6.6% dividend.

Natural-gas prices won’t stay down for long. If the Northeast freezes this winter, or a recovery sets in, expect Nisource’s shares to continue their winning streak.