In the wake of the most severe market correction since 2011, we believe the best deals for income-producing stocks can be found among U.S. companies.

This is one of the conclusions we reached in part one of a two-part Global Income Edge Special Report.  My colleague Ben Shepherd and I will be presenting a review of various industry sectors, how they have held up, and what bargains they offer.

This week I take a look at the utilities, housing/REITs and consumer defensive sectors. Next week Ben takes on telecoms, healthcare, financial services and consumer staples. These are areas that have been solid income investment areas in the past. 

Of course, we cannot be sure that the bottom has been reached in the market correction, but the fact that U.S. GDP grew at 3.7% in the second quarter suggests U.S stocks are a good bet. We have been playing the U.S. recovery for some time now, unveiling a Buy American portfolio in February.

However, finding undervalued income investment opportunities, even after a market correction, is still going to be difficult for the following reasons:

1. Flight to Quality: Specific companies could become overbought.

2. Increased Volatility.

3. Stimulus and Buybacks: Years of stimulus and corporate stock buybacks mean zombie companies are hiding among true performers

To cut through that noise we identified companies whose price-to-earnings ratios had fallen near their historical averages, and then applied other metrics, as well as our valuation model, to find income opportunities.

Sector Review

In our sector review, we have identified a number of companies that may be considered potential investments. We believe it is still too soon to begin adding to the portfolio as we believe markets still have not fully stabilized.

This exercise is mainly designed to offer guideposts to investors as to the companies and industries that GIE is tracking that may be added to the portfolio in the future. 

Utilities

Given its typical safe harbor status, on the surface it was surprising to see that utilities sector stock values fell by more than 4 percentage points, or as much as the broad market S&P 500 index on the worst days of the correction.

But when you looked closer, some names held their value better than others. The market favored companies with greater renewable energy exposure or utilities that were located in faster growing markets.

We have long been anticipating the implementation of the Environmental Protection Agency’s Clean Power Plan, which regulated carbon emissions, and makes firms with greater exposure to renewables and natural gas more valuable.   

That’s why Conservative Holding Southern Co.’s acquisition of AGL Resources positions the company for greater earnings given the projected increased use in natural gas. We were pleased to find that Southern, even after the correction, continued to be undervalued when we applied our dividend discount model. With a dividend yield of 4.86%, SO is a Buy up to $55. 

Utilities not in our portfolios that our model found undervalued were U.S. based CenterPoint Energy (NYSE: CNP) and Spain-based Red Electrica Corporation (CATS: REE).

CenterPoint Energy is a diversified electric and natural gas utility serving markets in Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma and Texas.

We believe the firm’s value held because about 65% of CenterPoint’s revenue is derived from regulated activities in areas with above-average economic growth. Though our model indicated only marginal price appreciation, the firm has a stellar 5.25% yield. We’ll be watching this one closely.

Meanwhile, Red Electrica’s improved prospects are likely a result of Spain’s ongoing recovery, as GDP growth forecasts rise to 3.1% for the country. The firm operates Spain’s electric grid and as the economy improves and there is more power demand, the firm collects tolls on moving increasing amount of power around the grid.

Grid operators, a recent invention with the unbundling of the generation from transmission through deregulation is a favorite of GIE, as there is no commodity risk, generally.

We have been following Red Electrica for some time but had been wary given the government cutbacks in regulated rates during Spain’s recession in the last few years. Further, we wish this stock traded on a U.S. market such as the New York Stock Exchange; a key GIE criteria.

But we do make exceptions in extraordinary circumstances, and will keep watch on this potentially undervalued opportunity that carries a 4.17% dividend yield.

Consumer Defensive

We were a little disappointed by how few real undervalued opportunities there were in the consumer defensive sector when looking at PE ratios and which firms dropped to near their historical averages. This is no doubt because everyone has gone defensive.

Nevertheless, showing up on our screens, we can report that Conservative Holding Unilever (NYSE: UL) continued to be an undervalued opportunity after the correction.  With a dividend yield of 2.95%, UL is a Buy up to $45.

But we were surprised that the model still showed consumer defensives such as Walmart (NYSE: WMK), Anheuser-Busch InBev (ENXTBR: ABI) still appeared overvalued.

Even the Campbell Soup Company (NYSE: CPB), the ultimate Consumer Defensive, was also slightly overvalued in our dividend discount model. Though as previously noted it’s likely a result of an investor flight to safety that has pushed valuations up.  

Housing/REITS

We continue to view the entire REIT sector generally undervalued or oversold as many investors left the sector in anticipation of the Federal Reserve raising rates. But with most forecasts for gradual increases, we believe investors will be compelled to return to higher yielding REITs sooner rather than later. 

In fact, a recent Credit Suisse Report supports this view, before the correction, they found that REITs traded at a 10% discount to NAV vs. an historical average of just 1%. The bank has said that rate fears are overblown and investors should buy REITS.  

In fact, #1 Best Buy pick HCP Holdings (NYSE: HCP), with a 5.86% dividend yield, held up under the scrutiny of our screens and continues to be an undervalued opportunity.  HCP is a Buy up to $44

One REIT not in our portfolios that caught our attention was RLJ Lodging Trust (NYSE: RLJ).

RLJ Holdings Trust acquires premium, full-service hotels, which typically generate most of their revenue from room rentals, have limited food and beverage outlets and meeting space, and require fewer employees than larger hotels. Given that business spending is expected to increase 4% this year, these types of properties should do well.

We were impressed with the firm’s results that showed for the six months ended June 30, Adjusted Funds From Operations (FFO) increased $18.2 million to $165.3 million, representing an increase of 12.3 percent over same quarter a year before. We’ll be keeping a watch on this potential holding.

Please watch for next week’s Income Without Borders as my colleague Ben Shepherd focuses on everything from telecoms to banks to the healthcare sectors for potential undervalued opportunities that we have identified.