A choppy economy is supposed to be good for defensive investors looking for safety in the utilities sector. After all, try living these days without water, electricity and even natural gas. Unless your home is entirely off-the-grid AND has its own well, you are paying the local utilities for their power and water. The albatross for utilities was the Federal Reserve’s interest rate hike campaign with 11 hikes up to 2024.
Much of 2023 and even 2024 were difficult times for investors in utilities. Those dividends remained in place, but frankly they just were not as high as other sectors. Investors also had the option of CDs, Treasuries and corporate bonds offering higher yields. Utilities rely on borrowing quite heavily, and higher interest rates jack up their cost of investment and operations. Their ability to raise prices to keep up with inflation may also be limited in many local markets. Regulatory pressures have been higher and may get worse. The costs to repair and build out key infrastructure are not cheap propositions. Add these factors up and it’s no shock that utilities stocks have suffered along the way.
Oggonomics is evaluating the utilities sector for long-term investors. Day traders and swing traders usually avoid the utilities sector. That said, the long-term views presented here do not at all imply that even the sector leaders’ stocks cannot fall again. In fact, the stock charts screen as “overbought” on a short-term technical indicators (MACD, RSI). The trends of more artificial intelligence and the ongoing buildout of EV charging stations may also act as longer term call-options that could bring more grid revenues than are currently expected.
The longer-term pressure hanging over utilities stocks may finally be in the rear-view mirror. That view would likely remain firm even if the utilities sector gave back most of the fresh gains. The Utilities Select Sector SPDR Fund (NYSEArca: XLU) has risen 10% in less than a month, and it is currently up 15% year-to-date.
It is quite possible that the first-half of 2024 could prove in time to have been the best time to buy utility stocks in years. Long-term investors with a multi-year outlook are not usually trying to pick exact bottoms. Still, some investors will want to wait for a pullback or sell-off for a better entry point rather than blindly jumping in. A key driver for utilities stocks heading into 2025 is that the next 100 basis point move in interest rates is more likely to be lower rather than higher. That said, the Efficient Market Hypothesis has a hard enough time pricing in even the known events — let alone pricing in adverse events that pop up out of the blue.
These long-term views are not intended to be investment advice. And for further disclosure, the author of this report (Jon Ogg) is a long-term investor in utilities.
At this time, there are 31 of the S&P 500 index members classified as utilities. While defensive investors may want “value” stocks, none of these major utilities trade near their book value. These stocks are often valued at 15 to 20 times expected earnings, which may also not scream “value.” Still, all of these utilities featured are projected to have earnings growth in 2024 and again in 2025.
Here are 4 individual utilities stocks and the key ETF featured by Oggonomics for long-term investors to consider looking beyond 2024.
HEY, THERE’S AN ETF FOR THAT!
The Utilities Select Sector SPDR Fund (NYSEArca: XLU) is the go-to investment choice for utilities investors. Its daily average volume translates to more than $1 billion bought and sold by ETF investors each day at current prices and volume.
The top ten holdings make up about 60% of the ETF’s assets. And the top five utilities alone (NextEra, Southern Company, Duke, Constellation, Americ Electric Power) account for about 40% of the ETF’s entire weighting. Those five top holdings also have a combined market cap above $400 billion as well. Its quarterly dividend varies based on the payouts it takes in from the individual utilities, but the last 4 payouts would imply a dividend payout of 3.15% based on the current $69.00 ETF share price.
THE WATER LEADER!
American Water Works Co. Inc. (NYSE: AWK) is the top water utility in North America with a market cap that is back above $25 billion. It serves over 14 million people in 14 U.S. states. The stock recently bottomed in the $113 to $114 range, similar to where it bottomed in 2023. With a 10% stock bounce in less than a month, many investors will want to wait for a pullback.
American Water’s 2.15% dividend yield is low versus the utility sector because water utilities have lower dividends than typical gas or electric utilities. The consensus analyst price target is also closer to $135 but some key firms have had higher target prices. This stock peaked close to $190 at the end of 2021, so the recent $113-$114 lows represented a full 40% plunge from its highs.
WATER & GAS
Essential Utilities, Inc. (NYSE: WTRG) is a utility that is more diversified between offering natural gas (Peoples) and water (Aqua) utility services to about 5 million people in 9 states.
Its stock has been difficult for many investors to value as a split of water and nat-gas, and another issue in the Peoples acquisition in 2020 was that it was all-cash at a $4.275 billion enterprise value. That deal is now about 4 years behind it and the market cap today is $10.5 billion.
Essential Utilities’ stock has done very little since its merger, but (around $38.75 at this time) it did trade to above $52.00 in late-2021. The consensus analyst target price is $44.12 and it sports a 3.2% dividend yield.
THE TURNAROUND
FirstEnergy Corp. (NYSE: FE) may seem close to a 52-week high, but its stock is still 20% to 25% under its pre-scandal highs from recent years. The ongoing regulatory uncertainty from bribery charges has mostly passed. Its electric system serves over six million customers in Ohio, Pennsylvania, New Jersey, West Virginia, Maryland and New York.
To offer some proof that business is getting better here, First Energy raised its dividend twice (almost 4.4% as of now) within the last year and the company recently beat the mid-point of its own earnings guidance despite a mild winter. Its balance sheet has been strengthened and both Moody’s and S&P raised its corporate credit ratings. First Energy also has a targeted long-term goal of 6% to 8% growth in its operating earnings per share.
BIGGEST OF THEM ALL!
NextEra Energy, Inc. (NYSE: NEE) is the parent of the former FPL and is America’s largest utility with a market cap near $150 billion. Complicated financing with NextEra Energy Partners (NYSE: NEP) has acted as an overhang for NextEra Energy. The stock is still down over 20% from its late-2021 highs.
On top of its 12-plus million customers in Florida, its map for battery storage, wind and solar now spans most states in America. There may seem like better yields than its 2.8% dividend, but NextEra see earnings growth of 6% to 8% in 2025-2026. The company has also targeted 10% annual dividend growth through 2026.
At almost $72.00, the consensus analyst target price of $73.50 is dwarfed by more aggressive targets from Wells Fargo ($85), BMO Capital ($78) and Morgan Stanley ($79).
