How Utility Stocks Have Kept Their Spark

Rising interest rates and inflation are often bottlenecks for high-value utility stocks, but these are unusual times.

The sector is the second-best performer in the US after the energy year so far, outperforming the S&P 500 index by 15 percentage points through Friday. That leaves utility stocks trading at an average of nearly 20 times earnings over the past 12 months — close to all-time highs and nearly a fifth richer than the S&P 500 index. Last time The utility stocks that achieved such a large premium was during the Covid-19 market panic in March 2020. The steadfast sector has typically traded with a slight decline relative to the broader index over the past decade. .

When the market fears a recession, collecting monthly checks is understandable for investors. Cash-strapped consumers are more likely to return to dining or shopping before the risk of power or gas outages. According to Jay Rhame, chief executive officer of Reaves Asset Management, which manages utility exchange-traded funds, by some measures, utilities today look more defensive today than they did years ago. In recent years, it has become much simpler for utilities to sell or spin off units with less or less risk associated with their proprietary, managed business. Exelon,

for example, earlier this year a business unit was exposed to a competitive electricity market. CMS Energy last year sold off a subsidiary of the bank.

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However, the industry’s recovery is something of an anomaly given the macroeconomic environment. Utilities stocks tend not to do well with rising interest rates for two reasons: First, the utilities industry has a large debt burden, with stocks in the S&P 500 on average carrying double net debt. more than five times earnings before interest, taxes, depreciation and amortization, according to S&P Global Market Intelligence. Second, they are a bond alternative. As interest rates rise, the dividend yield of utilities begins to look less attractive than that of Treasury. At one point during the early 2020 recession, the dividend yield on utility stocks was nearly 4 percentage points higher than the yield on the 10-year Treasury note. That edge is now just 0.17 percentage points.

Also, high inflation tends to be bad news for utility companies. As inflation begins to drive up the overall cost of households, it becomes more difficult to convince utility regulators to charge higher rates. Regulators are often appointed by governors or elected, so they are not immune to views that currently have politicians blaming companies – from oil producers to oil companies. supermarket chain – for causing pain to consumers.

Nicholas Campanella, equity analyst at Credit Suisse, wrote in a report, referring to the return on equity of companies that “capsulate prices, as seen abroad in UK and elsewhere, he added that such moves are unlikely to happen in the US, but they are worth watching. For the time being, however, fears of inflation’s destructive impact on fixed-income investments may be weighing on another inflationary issue.

“At least with utilities, you get a growing source of income. And you would think that a utility income stream might be better in an inflationary environment than a fixed income stream,” said Mr.

The question is to what extent those cash flows will be squeezed by high interest rates and inflation. Furthermore, industry-specific clouds are also looming in this area, including lost momentum in Congress for the widely known Build Back Better package, which includes energy incentives clean. The most recent hurdle was the US Commerce Department’s investigation into whether Chinese solar manufacturers were evading solar tariffs – a development that could delay them significantly. new solar construction plans. Because utilities’ returns are largely based on how much they spend on the grid, delays in spending plans can slow income growth.

With investors seemingly finding fresh anxieties around every corner lately, the force holding the rest of the market could make gadgets like a hidden gem for a moment and a second. expensive coal in the future. However, in a weakening stock market, these power lines are starting to get stretched.

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Edmund DeMarche

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