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Investors, beware: utility stocks may become less predictable

If investors were to sum up utility stocks in one word, many would probably say “predictable.”

Known for having above-average dividends and stable earnings in all types of markets, these investments tend to attract investors looking to play defense rather than pursue growth.

But some fund managers say the industry may become less predictable in the years to come, perhaps even a little exciting. The global focus on climate change is shaking the industry, they say, and the US presidential election could shake it even more.

So far this year, utility stocks have lagged behind the broader market, penalized by a sharp drop in demand for electricity in the first half of 2020 amid coronavirus lockdowns. While the S&P 500 has returned around 8.25% year-to-date, utility stocks in the index have fallen nearly 1%. S & P’s utilities sector had grown 33.7% between the end of 2018 and the 2020 peak set on February 18.

Some investors say utility stocks are still too expensive, but others say the sector is in the midst of a transition that could give utility stocks a boost.

Utilities, they say, are investing billions of dollars in new factories to generate electricity from renewable sources such as wind and sunlight – and prepare for new demand as fleets of The country’s cars and trucks are switching from using petroleum products to clean electricity. The transition to renewables could accelerate if Joe Biden wins the U.S. presidential election in November, analysts say, as the Democratic candidate has offered to expand tax credits to promote the adoption of green technologies.

The result, according to some industry fans, is that fuel savings could allow utilities to increase their profits and remain strong dividend payers, even if consumers are spared large increases in their utility bills. .

“Investors need to think about utilities differently,” says Rob Thummel, senior portfolio manager at Tortoise Capital, which manages a series of energy portfolios, including 9’s Tortoise Energy Evolution Fund (TOPTX), $ 1 million. “There is more potential for growth than there has been.”

Wind and sun

U.S. utilities are on track to build 100,000 megawatts of new wind and solar power plants over the next 15 years, enough to replace nearly 10% of all energy produced today, according to S&P Global Market Intelligence.

Growing list of power companies pledging to reduce carbon emissions includes Minneapolis-based Xcel Energy,

a leader in the construction of wind power plants. Xcel has pledged to reduce its carbon emissions by 80% by 2030 and be carbon-free by 2050. American Electric Power,

the Columbus, Ohio utility, which provides electricity to customers in 11 states, has pledged an 80% reduction by 2050, and Edison International,

Southern California’s parent Edison, promises to do the same by 2030.

The shift to renewables in the United States would likely accelerate if Mr. Biden wins, analysts say. He pledged to join the Paris Climate Agreement as part of a larger $ 1.7 trillion plan to tackle climate change and pledged to make electricity carbon neutral. here 2035. In 2017, President Trump withdrew the United States from the Paris Agreement, which calls on the United States. Commit to reducing greenhouse gas emissions by 26% to 28% from 2005 levels by 2025.

“We have an underweight recommendation on the sector based on fundamental forecast and price dynamics, but that could change with a Biden-Harris victory,” said Sam Stovall, CFRA Research investment strategist.

Expensive or not?

Others, however, believe that utility stocks are still too expensive. Who’s right depends on which metric you’re looking at, says Travis Miller, Morningstar utilities analyst.

Based on the price of the benefits, they are expensive. The S&P utilities sector was recently trading at around 19 times this year’s earnings and 18 times the 2021 estimate, compared to 25 times and 20 times for the S&P 500.

But utilities have traditionally traded at a discount because of their lower growth rate, which for many investors is offset by their relatively high dividends. Major dividend-paying utilities like Duke Energy,

for example, can offer returns greater than 4%.

If you compare dividend yields in the utility industry to interest rates on investments like bonds, they are historically cheap, Miller says.

“The returns are good, slow and steady,” says Paige Meyer, utilities analyst at CFRA Research in Washington. “That’s why Warren Buffett loves utilities.”

The industry’s biggest challenge will be driving growth, even if going green helps profit margins, says Ethan Zindler, head of research for the Americas at Bloomberg NEF. Along with the shift to renewable energy, the great pressure on the climate has been to make buildings and manufacturing more energy efficient, which has pushed electricity consumption in the United States below 2008 levels, with strong expected decline as numbers arrive for 2020, thanks to lockdowns, he says.

“The demand numbers haven’t fluctuated that much, but more products are being built because they are getting cheaper,” Zindler says. “If I had to choose a threat to public services, it is not overinvestment, it is that demand for the product is not increasing.”

It all depends on whether investors, who used to own utilities as a single investment, will be willing to stick with them as they continue to undergo heartbreaking changes. What if utilities, which have been rapidly adding renewables for a decade, can continue to offset the capital costs of new plants with fuel savings, which has so far led to lower electricity prices for most taxpayers in inflation-adjusted dollars, according to the Labor Data department.

“This transition should translate into growth in earnings and dividends,” Miller says. “The key is to convince customers with any one-time costs that might arise.”

Mr. Mullaney is a writer in Maplewood, NJ. He can be reached at reports@wsj.com.

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