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Own utilities despite rising rate environment: Analyst

Despite the prospect of a Federal Reserve interest rate hike, investors should stick with utility stocks, analyst David Burks told CNBC Tuesday.

"They still offer attractive yields, regular earnings and dividend growth," the senior utility analyst with Hilliard Lyons said in an interview with "Power Lunch."

High-dividend paying stocks like utilities generally become less attractive when yields on Treasurys move higher.

Utility stocks were big winners last year, when bond yields fell and investors looked for income they were no longer able to get from bonds. This year, utilities are among the biggest losers as yields have edged higher. The sector slumped 7 percent in 2015.

The sun shines over towers carrying electical lines in South San Francisco, California.
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The sun shines over towers carrying electical lines in South San Francisco, California.

However, Burks pointed out that while higher rates may look like a headwind, recent history shows it doesn't mean the sector will underperform.

During the last period of higher rates, from mid-2004 through mid-2006, the Federal Reserve raised rates 16 times, and electrics actually outperformed the S&P 500 "by a fairly wide margin," he said.

The electrics didn't begin to significantly underperform until the Fed funds rate passed the yield of the average electric, he added, noting that the current Fed funds rate is 0.25 percent and the yield on the average electric utility company is 3.9 percent.

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Travis Miller, director of utilities equity research with Morningstar, believes the sector's short-term performance will continue to reflect interest rate movements, but said investors willing to hold utilities two years or more can get strong absolute returns.

"Absolute returns are going to stay in that 8 to 9 percent, most likely, regardless what interest rates do over the next 2 to 3 years," he told "Power Lunch."

"If you look at utilities investors who are buy and hold type of investors, you still have good yields out there relative to the Treasurys, and you still have good balance sheets, good dividend growth out there and absolute returns look really good."

While Miller still thinks the sector is 4 percent overvalued, he said the big drop in utilities has made some regulated names attractive.

Miller's picks include Southern Company, which he said has come down "substantially" and is now trading a discount, Duke Energy and ITC Holdings.

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Burks's favorite income pick is PPL. The 4.6 percent dividend yield is above the industry average of 3.9 percent, and the stock is trading at a discount, he said.

His favorite growth pick is NextEra Energy, which he said is looking for above average earnings growth of 5 to 7 percent. Burks thinks that should support a dividend growth of 6 percent going forward.

He likes American Electric Power for total return.

—CNBC's Brenda Hentschel and the Associated Press contributed to this report.

Disclosures: Burks, his firm and his family do not own PPL, NEE, AEP. Miller, his firm and his family do not own SO, DUK, ITC.

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