THE GABELLI UTILITIES FUND
THIRD QUARTER REPORT
SEPTEMBER 30, 2000
[PHOTO OF TIMOTHY O'BRIEN OMITTED]
TIMOTHY P. O'BRIEN, CFA
TO OUR SHAREHOLDERS,
The third quarter of 2000 was extraordinary. The tech-heavy Nasdaq came
under pressure, and equity investors sought the safe haven that utilities
traditionally afford. At the same time, improved earnings, particularly for the
generators, and accelerating industry consolidation added to the attraction of
utility shares. The confluence of these factors led to a very sharp rise in
electric and gas stocks. The run-up in utility stock prices was not supported by
changes in interest rates. Our world is changing. Utility investors may no
longer be prisoners of the yield curve. The old utility math (long bond yield
plus or minus 1-2% depending on dividend payout, dividend risk and one or two
qualitative factors determines utility stock price) doesn't seem to work any
more. Investing in utilities may no longer be largely an exercise in forecasting
interest rates and looking at yield spreads for relative bargains. Fundamentals
really matter now. That's exciting. We like it.
Electric and gas stocks rallied substantially in the third quarter. The
best performance was shown by companies that sell electricity in the merchant
wholesale market. Wholesale prices were very high, particularly in the West,
where hot, dry weather combined with low hydro availability led to skyrocketing
prices. Prices were also high in the Midwest and Northeast in spite of
unseasonably cool summer weather. Companies focused on electricity distribution
conspicuously lagged as investor concern mounted about their ability to pass on
the high wholesale prices to end users. California utility companies are
particularly exposed, with Pacific Gas & Electric and Southern California Edison
running up multi-billion-dollar deferred power bills that threaten as much as
half of the companies' book equity. Political pressure is mounting for something
to be done to alleviate rising prices, and the search for a villain is well
under way. The only risk to the rosy outlook for the wholesale generators in the
near-term is their vulnerability to charges of price gouging, profiteering and
market manipulation. This bears watching. The Fund owns wholesale generating
stocks, and they have performed extraordinarily well. Notwithstanding the
positive fundamental outlook, however, if the political rhetoric ratchets up, we
may need to take some chips off the table.
Water stocks generally traded sideways. The merger and acquisition boom
that made 1999 so exciting and profitable has stalled for the moment, and based
on fundamentals alone, these stocks are not cheap. Merger and acquisition
activity may pick up once pending deals have closed. In addition,
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INVESTMENT RESULTS (a)
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Quarter
-------------------------------------
1st 2nd 3rd 4th Year
--- --- --- --- ----
2000: Net Asset Value $11.76 $10.88 $12.08 -- --
Total Return 10.0% (5.7)% 13.1% -- --
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1999: Net Asset Value -- -- $10.01 $10.89 $10.89
Total Return -- -- 0.1%(b) 22.1% 22.3%(b)
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Average Annual Returns - September 30, 2000 (a)
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1 Year ..................................... 43.34%
Life of Fund (b) ........................... 39.37%
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Dividend History
---------------------------------------------------------
Payment (ex) Date Rate Per Share Reinvestment Price
----------------- -------------- ------------------
December 27, 1999 $1.325 $10.89
(a) Average annual and total returns reflect changes in share price and
reinvestment of dividends and are net of expenses. The net asset value of the
Fund is reduced on the ex dividend (payment) date by the amount of the dividend
paid. Of course, returns represent past performance and do not guarantee future
results. Investment returns and the principal value of an investment will
fluctuate. When shares are redeemed they may be worth more or less than their
original cost. (b) From commencement of investment operations on August 31,
1999.
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Sierra Pacific, a major Nevada electric and gas utility, has put its water
division up for sale. The water division sale is rumored to generate proceeds to
Sierra Pacific of $300 million or more, which would be a stretch for all but a
handful of buyers. This deal may spark renewed interest in the group.
Telecommunications stocks continued to suffer, weighed down by increasing
concern about imploding long distance pricing structures, as well as the
pervasive inability of many competitive local and long distance carriers to
achieve operational targets and to service their burgeoning debt loads. The
telecommunications environment is as ugly as we can ever remember seeing it.
Capital is no longer available except to the very highest quality companies, and
even to them the terms are extortionate. We have seen one Competitive Local
Exchange Carrier ("CLEC") bankruptcy (GST Telecom) and are likely to see
another, much larger CLEC go under soon. The strongest are now absorbing the
weak on highly advantageous terms. Verizon bought NorthPoint, a digital
subscriber line ("DSL") provider, for no premium after the stock had fallen over
70% from its high. In October, McLeod Communications bought the struggling
CapRock Communications for less than $200 million and, again, no premium for its
equity holders. SBC bought 10% of Covad, a national provider of DSL services, on
its own terms. This combination of bankruptcies and distressed fire sales must
go on for a while before the market clears.
The woes of the CLECs and the long distance companies have weighed on the
prices of the incumbent local exchange carriers (ILECs), also known as the local
telephone companies. This is understandable from a market psychology standpoint,
but we think that the bad news for the competitors of the ILECs must in some
sense be good news for the ILECs. For that reason we have elected to maintain
substantial positions in BellSouth and SBC Communications and we sold our
remaining long distance and CLEC positions early in July.
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INVESTMENT PERFORMANCE
For the third quarter ended September 30, 2000 the Gabelli Utilities Fund's
(the "Fund") total return was 13.11%. The Lipper Utility Fund Average had a
total return of 8.96% while the Standard & Poor's ("S&P") Utility Index gained
32.38% over the same period. The Fund's one-year total return of 43.34% compares
well with the 22.65% total return for the Lipper Utility Fund Average and the
equal 43.34% return for the S&P Utility Index. The Lipper Average reflects the
average performance of mutual funds classified in this particular category,
while the S&P Utility Index is an unmanaged indicator of electric and gas
utility stock performance.
The Fund is noticeably underperforming the S&P Utility Index on a year to
date basis and somewhat less substantially outperforming the Lipper Utility Fund
Average year to date, and this merits some discussion. The Fund is not a Utility
Index Fund, and its performance will by design deviate from the Index. Sometimes
that deviation will be positive, as it was in the fourth quarter of 1999 when
the Fund gained about 23% while the S&P Utility Index fell about 9%. Sometimes,
as has been the case this year, the Fund will lag the Index. Indices do not hold
cash or incur transaction costs, while funds do, and this has been a minor
negative for the Fund's performance versus the Index. The major negative factor
in the Fund's year to date performance relative to the S&P Utility Index,
however, has been the Fund's telecommunications holdings. There are no telecom
stocks in the S&P Utility Index any more; they were taken out by S&P in 1996
after the passage of the Telecommunications Act eliminated the franchised
monopoly that incumbent local exchange carriers previously enjoyed. While S&P is
entitled to its opinion about what a utility is, the vast majority of utility
funds, including this one, continue to invest in telecom stocks.
We invested heavily and successfully in telecommunications in 1999, when we
perceived that attractive values were available, and we cut back our telecom
positions very substantially during 2000 because electric and gas stocks looked
more attractive at that time. Telecommunications stocks will have their day
again, however, and when they do, we reserve the right to buy them and we
believe that doing so will prove to be in the interest of our shareholders.
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 really need from the standpoint of
economic efficiency. The balkanized structure of the industry is inherently
inefficient, and competitive forces are now punishing inefficiency. The industry
has consolidated substantially already, and would have done so even faster
except for regulatory paralysis impeding the pace of mergers and acquisitions.
Our investments in the electric stocks have primarily, though not exclusively,
focused on fundamentally sound, reasonably priced mid-cap and small-cap
utilities that are logical acquisition targets for large utilities seeking to
bulk up. We have not made major investments in the water sector, but if these
stocks come back to more reasonable valuations we would expect to initiate
positions. At the moment, our investments in the telephone utilities have been
focused primarily on the larger domestic, incumbent local exchange carriers.
COMMENTARY
The once-homogeneous electric utilities are now looking much less similar.
A handful of companies have built upon their substantial size and scale
advantages to penetrate, and perhaps dominate, emerging wholesale and retail
bulk power and energy services markets. Some companies
3
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have sold off their generating assets and now supply and distribute electricity
to end customers. This looked like a low risk business, but this summer's
wholesale price spike left the transmission companies exposed to substantial
supply losses as wholesale prices exceeded retail rates. In the U.S. today, we
are learning the same hard lesson learned in the U.K. over the past five years:
generation assets provide a physical hedge against price volatility, and supply
businesses not backed by physical generation assets are very risky indeed.
The condition of the gas distribution utilities is generally stable and
sound. Pipeline companies are running into some earnings pressure as long
term contracts run off and are replaced with shorter-term deals. Arbitrage
pressures have also compressed pipeline margins, since real world gas
transportation rates are now limited to basis differentials, regardless of what
the tariffed rate happens to be. In addition, near-term excess pipeline capacity
is putting pressure on transportation rates. The margin pressure should be
manageable, but we are watching developments carefully. The pressure on
transportation rates is, however, being more than offset by improved midstream
results and rising profits on the E&P side. Gas stocks, particularly the
pipelines, were some of the better-performing stocks in the Fund's portfolio in
the third quarter.
Water companies, with few exceptions, are doing well in a low risk, slow
growth, highly capital-intensive business. Telecommunications companies continue
to generate very impressive earnings growth in the face of mounting competitive
pressures. ILECs are generating EPS growth in the low teens, trade at half the
market multiple, and have solid balance sheets and substantial cash flows. We
were further attracted to U.S. local exchange carriers because they looked very
cheap compared to their European peers, and we felt that this valuation
disparity would narrow or reverse. This has largely occurred, although most of
the disparity was eliminated by the European companies' stocks falling rather
than our domestic telecommunications stocks rising. So be it. We still like the
U.S. local telecommunication companies and have added to holdings in both the
third quarter and in early October.
LET'S TALK STOCKS
COASTAL CORP. (CGP - $74.125 - NYSE) is a major natural gas pipeline, with
significant oil and gas refining and processing operations. El Paso Energy is in
the process of acquiring Coastal. We bought Coastal as a way of acquiring El
Paso Energy shares at a discount while increasing the Fund's weighting in the
attractive natural gas pipeline sector. Coastal has been one of the main drivers
of the Fund's performance in the third quarter, having risen over 70% since the
position was initiated in the first half of the year.
GPU INC. (GPU - $32.4375 - NYSE) was our pick as National Grid's acquisition
target, as we discussed at length in the second quarter shareholder letter.
First Energy of Ohio beat the Grid to the punch, and in early August announced
its acquisition of GPU for $36.50 per share. The Grid had other names in its
little black book, however, and announced its own deal less than a month later.
MCN ENERGY GROUP INC. (MCN - $25.625 - NYSE) is a large natural gas distribution
utility serving southeastern Michigan. MCN is under agreement to be acquired by
DTE Energy for $28.50 in cash and stock. The acquisition is hung up at the FTC,
which continues to have concerns about competition in generation and in energy
supply in the overlapping service territories. Recently the companies filed a
proposed settlement with the FTC that will hopefully lead to a successful close
of the merger in the fourth quarter.
4
<PAGE>
NATIONAL FUEL GAS CO. (NFG - $56.0625 - NYSE) is a major natural gas
distribution company serving western New York State and northeastern
Pennsylvania. The company has major natural gas storage assets, which are
increasingly important in ensuring ready availability of gas close to the point
of use. NFG also has a major oil and gas exploration and production operation.
We own the stock because it is cheap. In addition, NFG is the last remaining
significant natural gas distribution and storage company in the Northeast, all
of the others having been acquired by electric utilities. While NFG has stoutly
maintained its independence for many years and continues to do so today, and
while NFG management objects to the company being discussed as an acquisition
target, we think that the company is ultimately destined to go where so many of
its peers have already gone. We note in passing that the company's capable
senior management team owns a lot of stock, and that its chairman, Bernard
Kennedy, is in his late 60s. Enough said.
NIAGARA MOHAWK HOLDINGS CO. (NMK - $15.75 - NYSE) was the National Grid's second
choice. The Grid bought New England Electric in 1999, paying up for that
company's high quality and acquiring a superior management team to run its U.S.
operations. The Grid spent most of this year looking for a "fixer-upper" that
could be acquired relatively cheaply and brought up to its, and New England
Electric's, higher standards. Niagara Mohawk certainly fits the bill. Niagara
Mohawk bought its way out of a lot of above-market purchased power contracts at
a heavy price, levering up the balance sheet and severely diluting its earnings.
Operating and maintenance costs were among the worst in the U.S. on a per
customer basis. Assuming that the Grid can attain its cost reduction targets of
$90 million, the acquisition of Niagara Mohawk will be accretive to the Grid's
earnings per share in the first year. We think that the Grid will substantially
exceed the anticipated savings, and that the acquisition will be a home run.
RGS ENERGY GROUP INC. (RGS - $28.1875 - NYSE) is a small electric and gas
utility serving metropolitan Rochester, NY. RGS is sandwiched neatly between
Niagara Mohawk and Energy East's service territory, and would be an easily
digested bolt-on acquisition for either. Energy East has bought five electric
and gas utilities in New England and New York in the past eighteen months, while
Niagara Mohawk announced in September its acquisition by the National Grid of
the U.K., which already owns New England Electric and Eastern Utilities of
Massachusetts. We think that RGS is in position to be acquired by one or the
other in the next year or two. We'll be sorry to see it go, since its management
team is one that we respect, but we think that RGS's time is at hand.
SBC COMMUNICATIONS INC. (SBC - $50.00 - NYSE) is one of the largest ILECs. The
stock has been weighed down by estimate reductions following the Ameritech
acquisition, and concern about the impact of competition. The competitors
currently are the ones who are suffering, however, and SBC is promising to
deliver EPS growth off of the rebased earnings. With capital expenditures
peaking this year at $13 billion and declining next year to $9-10 billion as
Project Pronto spending winds down, the company's free cash flow should improve.
TECO ENERGY INC. (TE - $28.75 - NYSE) is a small electric utility serving Tampa,
Florida. TECO was one of the few successfully diversified electric utilities,
with a big barge business and a struggling coal handling and shipping business.
Earnings growth slowed in the late 1990s, and TECO lost its customary premium
valuation. New management has done well in reinvigorating the company, and
earnings are now growing nicely again. The stock should be acquired in time, we
think, but as long as the current capable management team keeps up the good
work, we are willing to wait.
5
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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 Fund and other Gabelli Funds are available through the
no-transaction fee programs at many major brokerage firms.
WWW.GABELLI.COM
Please visit us on the Internet. Our homepage 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
The major factors depressing utility stock prices in 1999 and early this
year have been rising long interest rates and investors' infatuation with
technology stocks. With long rates perhaps having peaked for this cycle and with
technology stocks now coming under some pressure, utility price performance is
likely to continue to improve in both absolute and relative terms.
Sincerely,
/s/ SIGNATURE
TIMOTHY P. O'BRIEN, CFA
Portfolio Manager
October 16, 2000
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MONTHLY DISTRIBUTIONS -- $0.07 PER SHARE
----------------------------------------
Reinvestment Date | Reinvestment Price Reinvestment Date | Reinvestment Price
------------------|------------------- -------------------|-------------------
January 27, 2000 | $10.70 June 28, 2000 | $11.12
February 25, 2000 | $10.85 July 27, 2000 | $10.80
March 29, 2000 | $11.82 August 29, 2000 | $11.15
April 26, 2000 | $11.19 September 27, 2000 | $11.96
May 26, 2000 | $10.64
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TOP TEN HOLDINGS
SEPTEMBER 30, 2000
------------------
RGS Energy Group Inc. National Fuel Gas Co.
SBC Communications Inc. Calpine Corp.
Coastal Corp. (The) MCN Energy Group Inc.
TECO Energy Inc. BellSouthCorp.
GPU Inc. Niagara Mohawk Holdings 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.
6
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THE GABELLI UTILITIES FUND
PORTFOLIO OF INVESTMENTS -- SEPTEMBER 30, 2000 (UNAUDITED)
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MARKET
SHARES VALUE
------ ------
COMMON STOCKS -- 93.9%
ENERGY AND UTILITIES: ELECTRIC -- 42.5%
4,000 AES Corp.+ .................. $ 274,000
4,000 Calpine Corp.+ .............. 417,500
11,000 DPL Inc. .................... 327,250
9,000 DTE Energy Co. .............. 344,250
17,000 Edison International ........ 328,312
13,000 GPU Inc. .................... 421,687
5,000 Kansas City Power & Light Co. 133,437
1,000 Maine Public Service Co. .... 24,500
25,000 Niagara Mohawk Holdings Inc. 393,750
14,000 Potomac Electric Power Co. .. 352,625
3,000 SCANA Corp. ................. 92,625
6,000 Southern Co. ................ 194,625
15,000 TECO Energy Inc. ............ 431,250
5,600 UIL Holdings Corp. .......... 288,050
----------
4,023,861
----------
ENERGY AND UTILITIES: INTEGRATED -- 22.7%
15,000 Energy East Corp. ........... 339,375
1,500 Enron Corp. ................. 131,438
6,000 Entergy Corp. ............... 223,500
16,000 MCN Energy Group Inc. ....... 410,000
4,000 Montana Power Co. ........... 133,500
9,400 NSTAR ....................... 378,350
16,000 RGS Energy Group Inc. ....... 451,000
2,700 Southern Energy Inc.+ ....... 84,713
----------
2,151,876
----------
ENERGY AND UTILITIES: NATURAL GAS -- 19.7%
6,000 Coastal Corp. (The) ......... 444,750
5,600 Dynegy Inc., Cl. A .......... 319,200
6,000 El Paso Energy Corp. ........ 369,750
7,500 National Fuel Gas Co. ....... 420,469
7,500 Williams Companies Inc. (The) 316,875
----------
1,871,044
----------
MARKET
SHARES VALUE
------ ------
TELECOMMUNICATIONS: LOCAL -- 9.0%
10,000 BellSouth Corp. ............. $ 402,500
9,000 SBC Communications Inc. ..... 450,000
----------
852,500
----------
TOTAL COMMON STOCKS ......... 8,899,281
----------
PREFERRED STOCKS -- 1.0%
ENERGY AND UTILITIES: INTEGRATED -- 1.0%
1,500 Southern Energy Inc.,
6.25% Cv. Pfd. ............. 99,469
----------
PRINCIPAL
AMOUNT
---------
U.S. GOVERNMENT OBLIGATIONS -- 6.2%
U.S. TREASURY OBLIGATIONS -- 6.2%
$591,000 U.S. Treasury Bills,
6.12% to 6.15%++,
due 11/24/00 to 12/14/00 ... 584,549
----------
TOTAL INVESTMENTS -- 101.1%
(Cost $8,165,001) ......... 9,583,299
OTHER ASSETS AND
LIABILITIES (NET) -- (1.1%) (103,339)
----------
NET ASSETS -- 100.0%
(784,931 shares outstanding) $9,479,960
==========
------------------------
+ Non-income producing security.
++ Represents annualized yield at date of purchase.
7
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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 TRUSTEES
Mario J. Gabelli, CFA Mary E. Hauck
CHAIRMAN AND CHIEF (RETIRED) SENIOR PORTFOLIO MANAGER
INVESTMENT OFFICER GABELLI-O'CONNOR FIXED INCOME
GABELLI ASSET MANAGEMENT INC. MUTUAL FUND MANAGEMENT CO.
Anthony J. Colavita Karl Otto Pohl
ATTORNEY-AT-LAW FORMER PRESIDENT
ANTHONY J. COLAVITA, P.C. DEUTSCHE BUNDESBANK
Vincent D. Enright Werner J. Roeder, MD
FORMER SENIOR VICE PRESIDENT MEDICAL DIRECTOR
AND CHIEF FINANCIAL OFFICER LAWRENCE HOSPITAL
KEYSPAN ENERGY CORP.
OFFICERS AND PORTFOLIO MANAGERS
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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GAB470Q300SR
[PHOTO OF MARIO GABELLI OMITTED]
THE
GABELLI
UTILITIES
FUND
THIRD QUARTER REPORT
SEPTEMBER 30, 2000
