By Alex Kimani
- The utilities sector has been the worst performer of all the United States’ 11 market sectors.
- Utility stocks can help stabilize a portfolio by lowering volatility and risk thanks to the fact that the sector is heavily regulated.
- Although investing too heavily in utilities can be a drag on your portfolio during good times, their defensive qualities make them an invaluable part of a healthy portfolio.
At a time when the energy industry continues garnering the lion’s share of investor enthusiasm, utilities appear like a forgotten sector. The sector has been the worst performer of all the United States’ 11 market sectors, with its frequently used benchmark, the Utilities Select Sector SPDR ETF (NYSEARCA:XLU), managing a paltry 7.2% return in the year-to-date, badly trailing the broad market and the energy sector with gains of 25.1% and 53.7%, respectively.
There’s a method to the madness, though.
Utilities provide electricity, natural gas, and water and wastewater services to residential, commercial, industrial, and government customers. The sector tends to perform relatively well when concerns about slowing economic growth resurface and to underperform when those worries fade.
That’s partly the case because of the sector’s traditional defensive nature and steady revenues–after all, people need water, gas, and electric services during all phases of the business cycle, including during recessions. Further, low-interest rates typical of weak economic cycles provide cheap funding for the large capital expenditures required by this industry.
But with serious concerns about the Fed’s next course of action regarding interest rates, there’s no telling when the stock market bull run might be hitting the skids.
The US Federal Reserve is expected to start “tapering” in a matter of weeks, effectively reducing the amount of US government bonds it buys every month. Right now, the Fed has been purchasing bonds worth $120 billion every month, and the assets on its balance sheet have swollen to nearly $9 trillion. Although the markets have long anticipated the latest round of taper, investors are still skittish due to stubbornly high inflation and fears that the Fed might be forced to raise rates at a faster-than-expected clip in a bid to tame inflation.
Utility stocks can help stabilize a portfolio by lowering volatility and risk thanks to the fact that the sector is heavily regulated. Utilities tend to be more resistant to economic cycles than most other sectors of the economy because demand for utilities does not vary much. Most utilities have predictable cash flows, which enables many to pay decent dividends with higher yields than other fixed-income investments.
Utility companies tend to be slow-growing, but high-yielding and inexpensive relative to earnings. They are generally viewed as good defensive plays because of their relatively steady and safe cash flows both in both good and poor economic cycles. Utilities are more recession-proof than most sectors, as evidenced by their positive returns during the last recession when the rest of the market tanked.
Although investing too heavily in utilities can be a drag on your portfolio during good times, their defensive qualities make them an invaluable part of a healthy portfolio. Further, there could be significant government funding to utilities as part of clean-energy initiatives that would benefit the sector’s profit outlook.
Here are some utilities stocks to consider for your portfolio.
NextEra Energy (NYSE:NEE) is a Florida-based clean energy company and America’s largest electric utility holding company by market cap. NEE is the world’s largest producer of wind and solar energy with 45,900 megawatts of generating capacity. The company owns eight subsidiaries, with the largest, NextEra Energy Services, supplying 5 million homes in Florida with electricity.
It’s worth noting that last year, NextEra briefly surpassED ExxonMobil (NYSE:XOM) to become America’s largest energy company, an ominous warning that renewables are ready to take over the mantle from their fossil fuel brethren.
Last year, NextEra’s management reiterated its 30×30 goal to install more than 30 million solar panels, or roughly 10,000 megawatts of incremental solar capacity, in Florida by 2030 through one of its subsidiaries, Florida Power & Light (FPL).
NextEra is unabashedly pro-renewables: Company CFO Rebecca Kujawa has even declared that the company is “…particularly excited about the long-term potential of hydrogen” and discussed plans to start a pilot hydrogen project at one of its generating stations at Okeechobee Clean Energy Center owned by its subsidiary, Florida Power & Light (FPL).
NextEra’s usual modus operandi involves conducting small experiments with new technologies to establish their cost effectiveness before going big if the trials are successful. The company completed its SolarTogether program in the second quarter, which is likely to positively impact performance going forward.
NEE shares have been climbing after the company topped third-quarter earnings expectations, including a record quarter for renewable energy origination, adding 2,160 MW to its backlog of projects.
During Q3, NextEra Energy Resources added 1,240 MW of new wind projects in its best-ever quarter of wind additions, as well as 515 MW of solar projects and 345 MW of energy storage projects to its renewables and storage backlog.
NextEra says Q3 adjusted earnings increased 12.3% to $619M, while profit at its Florida Power & Light electric utility unit rose 10% Y/Y to $836M.
NextEra maintains guidance for FY 2021 adjusted EPS of $2.40-$2.54, and it expects to grow 6%-8% off the expected 2021 adjusted EPS for 2022-23.
#2. American Water Works
American Water Works Inc. (NYSE:AWK) is a New Jersey-based public utility company that provides drinking water and wastewater services to 15 million people in all but four states in the United States. AWK is the largest publicly traded water and wastewater utility in the U.S., which helps the company enjoy stable revenue streams and low demand elasticity, thus enabling the company to pay more consistent higher dividends. Indeed, whereas water utilities might seem boring, AWK significantly outperformed the S&P 500 over the last 5 years after gaining 140% vs.125%.
This outperformance could continue for years to come.
AWK management has guided for 7-10% EPS and dividend growth through 2024, with the growth runway probably running for much longer. Further, AWK’s proven business model and the rise of ESG investing make it well-positioned to continue to deliver for long-term investors.
#3. AES Corp
The AES Corporation (NYSE:AES) is a Virginia-based, Fortune 500 global power company that provides sustainable energy, including thermal and renewables, to 14 countries. The company owns and manages $34 billion in total assets, and generated $10 billion in revenue in 2019. For 2020, the company projected that it derived 36% of its PTC (pre-tax contribution) from the U.S.; 31% from South America, 22% from Mexico and Central America, and the remaining 11% from Asia and Europe.
AES has been making strong progress in its transition to renewable energy, and managed to retire 1.2 GW of coal in the U.S. and Chile last quarter, thus bringing its coal generation down to 29% of total output and hitting its target to lower coal generation to below 30% of its total energy output by the end of the year. AES sees coal contributing less than 10% of its total energy output by 2030.
AES has a solid history of raising its dividends over the years, which now sits at 2.4%.
#4. Edison International
California-based power producer Edison International (NYSE:EIX) is a giant utility that generates electricity through natural gas, hydroelectric, diesel, nuclear, and photovoltaic sources. Edison combines deep value as well as exposure to the decarbonization/electrification trend.
Southern California Edison, one of Edison International’s subsidiaries, is one of the country’s largest investor-owned utilities, serving 15 million people in Central, Coastal, and Southern California. Based in Rosemead, California, SCE not only is the primary electricity supply company in Southern California but has also consistently ranked among the top 10 utilities in the country delivering solar power to their customers since 2007.
On average, the company has been connecting an average of 3,600 solar customers to its grid every month, which works out to a customer coming online every 12 minutes. In 2018, SCE added 547 megawatts of solar energy to the grid, which is the equivalent to removing 231,839 cars from the road for a year.
SCE offers a “green rate” that allows its customers to source all their electricity needs entirely from renewable sources. In 2017, the company commissioned two new hybrid electric-gas peaker plants to accommodate peak demand and also operates a regulated gas and water utility.
#5. NextEra Energy Partners
NextEra Energy Partners, L.P.(NYSE: NEP) is one of NextEra Energy’s subsidiaries.
NextEra Energy Partners owns interests in dozens of wind and solar projects in the United States., as well as natural gas infrastructure assets in Texas. These contracted projects use leading-edge technology to generate energy from the wind and the sun.
KeyBanc analyst Sophie Karp has assigned an Overweight rating on NEP saying the company’s high-quality portfolio of renewable assets and heavily contracted cash flow with a pipeline of assets through sponsor NextEra Energy positions NEP for multiple years of double-digit distribution growth.
A couple of weeks ago, NextEra Energy Partners agreed to acquire a 50% interest in a 2,520 MW renewables portfolio from NextEra Energy Resources, and Apollo Global Management (NYSE:APO).
The portfolio, which is expected to be operational at the time of funding, consists of 13 utility-scale wind and solar assets, three of which include battery storage, that are diversified across U.S. power markets. NextEra Energy Partners expects to acquire the asset stakes for $849M plus its share of the portfolio’s total tax equity financings, which is estimated at $866M at the time of closing.
The partnership expects the deal to contribute adjusted EBITDA of $184M-$194M and CAFD of $58M-$67M, each on a five-year average annual run-rate basis.