Dividend stock bargain: A high-yielding utility stock on sale

Until recently, finding undervalued dividend stocks in this market has been a real challenge.  While there were plenty of dividend stock bargains to be found during the market lows in March 2009 – when no one wanted to buy them – the market’s spectacular run-up since then not only “corrected” that situation, but pushed valuations (and dividend yields) on most stocks to levels that were no longer tempting.

Now, with the market selling off (as it does on occasion, although apparently to the surprise of many), it’s once again presenting opportunities to buy some quality dividend stocks at reasonable values. Of course, as always, there’s plenty of bad news to explain the falling prices, and plenty of bearish analysts and market participants expecting “significantly” lower prices ahead.

Keep in mind that many of these same market “experts” just a month or two ago were giddily bullish over the market’s “low” valuation (based on optimistically projected 2011 earnings!) and predicting a continued market “melt-up.”  The best way to avoid falling into this trap is to have a longer-term perspective (not a trader mentality) and to use realistic and/or actual fundamental data and assumptions when trying to value stocks.

With that in mind, I thought I’d highlight in this and upcoming posts some individual dividend stocks that appear to be presenting good opportunities at current prices. In this post I’ll begin with FirstEnergy Corp. [[FE]], a high-yielding utility stock that’s currently down almost 60% from its 2008 highs:

FirstEnergy operates seven electric utilities (using nuclear, natural gas, coal and renewable sources) in Ohio, Pennsylvania, and New Jersey. It’s currently in the process of acquiring – through an all-stock deal – smaller Allegheny Energy (AYE), an electric utility using primarily coal-fired plants in Pennsylvania, West Virginia, Maryland, and Virginia.

Its stock has definitely taken a hit since that deal was announced – investors appear skeptical of the synergies FirstEnergy expects to accrue from the merger, as well as the debt burden it will take on to make the acquisition. In addition to implementation risk, another potential concern is the combined utility’s much greater exposure to coal-based energy – and possible associated regulations; on the other hand, if the merger works out as planned it could potentially be very positive for earnings (and the dividend) over the longer term.

Technically, the shares of FE – which are trading at about $35 and yielding almost 6.3% – are in a clear intermediate-term downtrend and certainly could trade lower. However, they are currently oversold and showing signs of positive divergences on an intermediate-term basis as well as a longer-term basis, suggesting a potential bottoming process in the coming weeks/months.

Valuation wise, FE appears undervalued here based on current (12-months trailing) and estimated earnings and earnings growth going forward, with an average estimated fair value somewhere in the $40s. In addition, the dividend appears safe, and could potentially grow at some point if the merger goes through and is ultimately accretive.

Also, the stock is currently rated 5 stars at Morningstar and was upgraded to “greatly undervalued” earlier this year at Ockham Research and recently upgraded to “buy” from “hold” at Citigroup. I’m currently short some 35-strike put options against FE – meaning I’m willing to buy the stock (have it “put” to me) if it trades below the strike price between now and when the options expire – and would consider buying the stock outright here at around $35 or lower as a long-term investment.

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