THE GABELLI UTILITIES FUND
THIRD QUARTER REPORT
SEPTEMBER 30, 1999
TO OUR SHAREHOLDERS,
September turned out to be an interesting time to launch a utility fund.
Interest rates were rising following two rounds of tightening monetary policy by
the Federal Reserve. Oil prices and gold prices rose sharply in the third
quarter, fueling the inflationary concerns normally seen during a long economic
expansion. The long-awaited out-performance of utility stocks in the second
quarter proved to be a head fake, and the electric and gas utility stocks
underperformed a sagging stock market in the third quarter. Water utilities did
much better, buoyed by takeover speculation following several announced
acquisitions during the summer. The telecommunications stocks basically moved
sideways. The outlook for utility stock performance in the fourth quarter looks
reasonably favorable, however. The bulk of the interest rate increases are
probably behind us. During nervous market environments such as the one we are in
currently, defensive issues typically do well. Looking beyond the immediate
future, electric, gas and water stocks are likely to benefit from continuing
consolidation, while telephone companies should continue to enjoy superior
growth.
INVESTMENT PERFORMANCE
Since inception on August 31, 1999 through September 30, 1999, The Gabelli
Utilities Fund's (the "Fund") total return was 0.10%. The Lipper Utility Fund
Average and Standard & Poor's ("S&P") Utility Index declined 0.21% and 4.79%,
respectively, over the same period. The S&P Utility Index is an unmanaged
indicator of electric and gas utility stock performance, while the Lipper
Average reflects the average performance of mutual funds classified in this
particular category.
COMMENTARY
IMPROVING FUNDAMENTALS BUCKING AN INTEREST RATE HEADWIND
Electric utilities are in good and improving condition. Those with low
generating costs never had many problems, while the high cost generators have
mostly restructured and are poised to recover their riskiest investments and
move on. The biggest challenge facing most companies now is how to deploy
capital and rising free cash flow at attractive rates of return. The condition
of the gas utilities is generally stable and sound. Water companies (with few
exceptions) are doing well, and telecommunications
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companies continue to generate very impressive earnings growth. The dismal
performance of utility stocks in the third quarter cannot be attributed to
deteriorating fundamentals; the fundamentals are strong and continue to improve.
The villain is rising interest rates. Interest rates at the long end of the
yield curve began to rise early in 1999. For several months, utility stocks
continued to rise in the face of rising long rates, which is highly unusual and
led to speculation that perhaps the correlation between utility stock prices and
long interest rates was breaking down. Alas, the utility stocks fell with a
resounding thud in the third quarter, and such talk is no longer heard.
The sell-off of utility stocks in the third quarter allowed us to pick up
shares at attractive prices. Once interest rates stop rising, the strong and
improving fundamentals in the industry are likely to lead to much better price
performance.
OUR APPROACH
There are over 80 publicly-traded, investor-owned electric utilities in
the U.S., and this is at least 50 more than we need. The balkanized structure of
the industry is inherently inefficient, and competitive forces are now punishing
inefficiency. The industry has already consolidated substantially, and would
have done so even faster except for regulatory sclerosis impeding the pace of
mergers and acquisitions. We are skeptical about the claims of the
mega-utilities to be able to deliver superior returns, but we believe that the
mid-cap and small-cap utilities are generally doing fine on their own and are
likely acquisition targets over time. Our investments in the electric and
natural gas stocks have generally focused on fundamentally sound, reasonably
priced mid-cap and small-cap utilities that are logical acquisition targets for
large utilities looking to bulk up. We have held off on taking the plunge into
water stocks for the moment, because of the substantial summer run-up in prices
following several acquisition bids. Our investments in the telephone utility
sector have been focused primarily on the larger incumbent local exchange
carriers. Recently, however, we did buy two long distance/data carriers that are
doing fine on their own and are also likely acquisition targets for larger
carriers.
LET'S TALK STOCKS
The following are stock specifics on selected holdings of our Fund.
Favorable earnings prospects do not necessarily translate into higher stock
prices, but they do express a positive trend which we believe will develop over
time.
DQE ENERGY INC. (DQE - $39.125 - NYSE) is a mid-sized electric utility serving
metropolitan Pittsburgh. As part of a restructuring plan approved by
Pennsylvania regulators, DQE is auctioning off its generating assets and will
use the proceeds to improve its already strong balance sheet. DQE has used much
of its free cash flow to buy back stock, and plans to buy back additional stock
in the future. The company has also moved aggressively into the water utility
business, investing over $250 million to acquire more than 300,000 water
customers in 13 states. While DQE is a logical acquisition target, it is doing
fine on its own. The company's 7% compounded EPS growth rate over the past five
years (driven partly by share repurchases and partly by returns on non-electric
investments) ranks ninth in the industry, yet DQE trades at a discount to the
electric utility average price/earnings ("P/E") ratio. In addition, we think the
company's management is outstanding.
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SCANA CORP. (SCG - $24.1875 - NYSE) is currently experiencing several problems.
Earlier in 1999, SCANA, the parent of South Carolina Electric & Gas, agreed to
buy Public Service of North Carolina for a large premium, at the same time
sharply reducing its own dividend rate. SCANA also entered the deregulated
natural gas supply market in Georgia, and is incurring heavy startup losses that
have caused the company to disappoint investor expectations. Investor concerns
about the company's strategy and performance have been largely ignored by the
company's management, which is understandably held in low regard by utility
investors. Utility investors are ignoring the company's highly successful
telecommunications investments: we value these investments at roughly $10 per
SCANA share pretax. The largest component of the telecom portfolio is nearly 10
million shares of Powertel, a southeastern wireless personal communications
services ("PCS") carrier providing mobile telephone services. Powertel has three
peer companies, VoiceStream, Aerial and Omnipoint. VoiceStream is in the process
of acquiring Aerial and Omnipoint, and acquiring Powertel would complete its
nationwide footprint. This could provide the catalyst to change investors'
negative perception of SCANA.
SPRINT CORP. (FON - $54.25 - NYSE) is the third largest long distance carrier
and the second-largest independent local telephone company in the U.S. Sprint
has positioned itself globally through a joint venture called Global One. Its
joint venture partners, France Telecom and Deutsche Telekom, each have a 20%
direct stake in Sprint. FON faces risks from prospective new entrants, including
the regional Bells, in its long distance business, which may be offset by the
"ION" high bandwidth network that the company is developing. Sprint PCS group is
the leading personal communications services ("PCS") carrier in the U.S., with
over four million customers and licenses covering over 230 million people. In
late September, Sprint was in talks to be acquired by MCI WorldCom, which we
would view favorably considering the substantial cost efficiencies that could
result and the potential for each company to fill the voids in the other's array
of products and services.
UNISOURCE ENERGY CORP. (UNS - $12.00 - NYSE) is a small and struggling electric
utility serving Tucson, Arizona. Following a series of disastrous miscues by
prior management in the 1980s, the company was left with a weak balance sheet
and the highest rates of any non-nuclear utility in the U.S. New management
worked hard to repair the damage, and their efforts are beginning to bear fruit.
Earnings should improve dramatically next year, as should the balance sheet, and
we expect the company to reinstate its long-omitted dividend fairly soon.
MINIMUM INITIAL INVESTMENT - $1,000
The Fund's minimum initial investment for both regular and retirement
accounts is $1,000. There are no subsequent investment minimums. No initial
minimum is required for those establishing an Automatic Investment Plan.
Additionally, The Gabelli Utilities Fund and other Gabelli Funds are available
through the no-transaction fee programs at many major discount brokerage firms.
3
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INTERNET
You can now visit us on the Internet. Our home page at
http://www.gabelli.com contains information about Gabelli Asset Management Inc.,
the Gabelli Mutual Funds, IRAs, 401(k)s, quarterly reports, closing prices and
other current news. You can send us e-mail at [email protected].
IN CONCLUSION
This has been a dismal quarter for utility stocks, which are likely to
struggle until interest rates peak. We continue to take advantage of the current
price weakness to build positions in fundamentally sound, reasonably priced and
well-positioned companies that are likely to do substantially better in a less
hostile interest rate environment.
The Fund's daily net asset value is available each evening after 6:00 PM
(Eastern Time) by calling 1-800-GABELLI (1-800-422-3554). The Fund's Nasdaq
symbol is GABUX. Please call us during the business day for further information.
Sincerely,
/s/ Timothy P. O'Brien, CFA
---------------------------
TIMOTHY P. O'BRIEN, CFA
Portfolio Manager
October 25, 1999
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TOP TEN HOLDINGS
SEPTEMBER 30, 1999
Sprint Corp. BellSouth Corp.
GTE Corp. Ameritech Corp.
Unisource Energy Corp. DQE Inc.
Alltel Corp. United Illuminating Co.
SBC Communications Inc. U.S. West Inc.
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NOTE: The views expressed in this report reflect those of the portfolio manager
only through the end of the period stated in this report. The manager's views
are subject to change at any time based on market and other conditions.
4
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<TABLE>
<CAPTION>
THE GABELLI UTILITIES FUND
PORTFOLIO OF INVESTMENTS - SEPTEMBER 30, 1999 (UNAUDITED)
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MARKET
Shares VALUE
------ -----
<S> <C> <C>
COMMON STOCKS - 73.8%
ENERGY AND UTILITIES: ELECTRIC - 21.9%
1,000 DQE Inc. $ 39,125
1,000 Kansas City Power & Light Co. 24,188
1,200 Scana Corp. 29,025
1,100 Teco Energy Inc. 23,237
3,800 Unisource Energy Corp.+ 44,888
800 United Illuminating Co. 38,700
--------------
199,163
--------------
ENERGY AND UTILITIES: INTEGRATED - 10.4%
400 Central Hudson Gas & Electric Corp. 15,750
500 Cinergy Corp. 14,156
900 LG&E Energy Corp. 19,125
600 RGS Energy Group Inc. 14,700
1,200 Sigcorp Inc. 30,600
--------------
94,331
--------------
ENERGY AND UTILITIES: NATURAL GAS - 5.4%
500 Piedmont Natural Gas Co. 15,156
1,100 Public Service Co. of North Carolina 34,100
--------------
49,256
--------------
TELECOMMUNICATIONS: GLOBAL - 2.2%
759 Global Crossing Ltd.+ 20,113
--------------
TELECOMMUNICATIONS: NATIONAL - 10.5%
600 GTE Corp. 46,125
900 Sprint Corp. 48,825
--------------
94,950
--------------
TELECOMMUNICATIONS: REGIONAL - 23.4%
600 Alltel Corp. 42,225
600 Ameritech Corp. 40,313
900 BellSouth Corp. 40,500
800 SBC Communications Inc. 40,850
600 US West Inc. 34,238
1,300 Versatel Telecom International NV, ADR+ 13,975
--------------
212,101
--------------
TOTAL COMMON STOCKS 669,914
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PRINCIPAL
AMOUNT
---------
U.S. GOVERNMENT OBLIGATIONS - 26.9%
$ 246,000 U.S. Treasury Bills, 4.56 to 4.73%++,
due 10/14/99 to 12/02/99 244,607
--------------
TOTAL INVESTMENTS - 100.7%
(Cost $905,228) 914,521
OTHER ASSETS AND LIABILITIES (NET) - (0.7)% (6,136)
--------------
NET ASSETS - 100.0%
(90,791 shares outstanding) $ 908,385
==============
NET ASSET VALUE, OFFERING AND REDEMPTION PRICE PER SHARE $10.01
==============
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+ Non-income producing security.
++ Represents annualized yield at date of purchase.
ADR-American Depositary Receipt.
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THE GABELLI UTILITIES FUND
One Corporate Center
Rye, New York 10580-1434
1-800-GABELLI
[1-800-422-3554]
FAX: 1-914-921-5118
HTTP://WWW.GABELLI.COM
E-MAIL: [email protected]
(Net Asset Value may be obtained daily by calling
1-800-GABELLI after 6:00 P.M.)
BOARD OF DIRECTORS
Mario J. Gabelli, CFA Karl Otto Pshl
CHAIRMAN AND CHIEF FORMER PRESIDENT
INVESTMENT OFFICER DEUTSCHE BUNDESBANK
GABELLI ASSET MANAGEMENT INC.
Anthony J. Colavita Werner J. Roeder, MD
ATTORNEY-AT-LAW MEDICAL DIRECTOR
ANTHONY J. COLAVITA, P.C. LAWRENCE HOSPITAL
Vincent D. Enright
FORMER SENIOR VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
KEYSPAN ENERGY CORP.
OFFICERS
Mario J. Gabelli, CFA Timothy P. O'Brien, CFA
PRESIDENT AND CHIEF PORTFOLIO MANAGER
INVESTMENT OFFICER
Bruce N. Alpert James E. McKee
VICE PRESIDENT AND TREASURER SECRETARY
DISTRIBUTOR
Gabelli & Company, Inc.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND AGENT
State Street Bank and Trust Company
LEGAL COUNSEL
Skadden, Arps, Slate, Meagher & Flom LLP
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This report is submitted for the general information of the shareholders of The
Gabelli Utilities Fund. It is not authorized for distribution to prospective
investors unless preceded or accompanied by an effective prospectus.
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[PHOTO]
THE
GABELLI
UTILITIES
FUND
INITIAL REPORT
SEPTEMBER 30, 1999
