Utility stocks, a popular haven for dividend investors, have lost some power this year as investors pile into technology names and other growthier parts of the market.
Utilities aren’t alone. The relative strength of a basket of defensive stocks, including consumer staples, utilities, and healthcare, against a basket of all other sectors “fell to its weakest level in 23 years in early September,” notes Bespoke Investment Group.
Still, utility stocks have had an especially hard time of late. The Utilities Select Sector SPDR exchange-traded fund (ticker: XLU), a proxy for large-cap utilities, is down 7% year to date, dividends included_the worst performer of the S&P 500’s 11 sectors.
By contrast, technology stocks in the S&P 500 have gained 38% through Sept. 18, Communication services was up 44%.
Nevertheless, there could be a silver lining for utility shares. Income-seeking investors looking for stable and growing dividends have a chance to at least nibble at stocks in an attractively valued sector. The relative valuation of utilities versus the S&P 500 is at “near historic lows,” says Teresa Ho Kim, an equity research analyst at J.P. Morgan Asset Management.
Adds Stephanie Link, chief investment strategist at Hightower Advisors: “You can get some of the biggest utilities in the country for pretty cheap multiples.”
Bobby Edemeka, a portfolio manager of the PGIM Jennison Utility fund (PRUAX), expects annual dividend growth for electric utilities to average around 5%, in line with earnings growth. “The fundamental outlook for utilities continues to be very, very strong,” says Edemeka.
The poor showing of utility stocks has been chalked up to several factors—one being rising bond yields. The Utility Select Sector SPDR ETF was recently yielding about 3.3%. That’s attractive for stocks, but it’s well below the 10-Year U.S. Treasury’s recent yield of 4.32%.
Until the Federal Reserve began to raise short-term rates early last year, utility stocks had the upper hand over many bonds for a long time.
These higher yields have increased borrowing costs for utilities, which tend to be very capital intensive as they build out their grids and related infrastructure.
No one knows just when the Federal Open Market Committee will decide to stop raising short-term interest rates and pivot to cutting rates. What we can know is that the FOMC is a lot closer to the end of its rate-tightening regimen than the beginning.
Whenever that turn does occur, it will take some pressure off the utility sector. “You’ve got to stay patient,” says Link, referring to utility stocks. “It is a real challenge at this point in the near term.”
One of her holdings is American Electric Power (AEP). The company, based in Columbus, Ohio, has a sizable geographic footprint that stretches over 11 states, including Michigan, Texas, Virginia, and Tennessee. It serves about 5.6 million U.S. customers with about 40,000 miles of transmission lines.
The stock, which yields 4.2%, has returned minus 13% this year, including dividends.
The company has faced some setbacks such as announcing earlier this year that it had terminated an agreement to sell its Kentucky subsidiary. And Texas regulators recently rejected $2 billion of planned renewable energy projects for Southwestern Electric Power, one of American Electric’s regional utilities, according to Morningstar.
Like other utilities, American Electric Power is spending heavily on capex to improve its grid and other infrastructure, including building out its production of renewable energy. Most of the company’s nearly $40 billion in capital spending through 2027 is for regulated investments—that is, utility assets that are overseen by government regulators, according to Morningstar.
Investors often prefer the stability and returns that these assets offer as opposed to businesses subject to the ups and downs of daily pricing.
To revamp its portfolio, American Electric Power is unloading assets. The company, for instance, announced last month that it had sold its 1,365-megawatt unregulated, contracted portfolio of renewable energy assets, including wind and solar.
Link says she is keeping close tabs on the company’s spending, including its capex. “They can get more efficient at what they are doing,” she says. “It really is a [return on equity] story. They have to improve that.”
These three utility stocks should have the financial wherewithal to keep growing their dividends.
|Company / Ticker||Dividend Yield||YTD Return||Market Value (bil)||2024E P/E Ratio|
|American Electric Power / AEP||4.2%||-13.2%||$41.2||14.3|
|CenterPoint Energy / CNP||2.6||-1.4||18.2||17.9|
|NiSource / NI||3.6||3.2||11.4||16.5|
Note: Data through Sept. 19; E=estimate
Portfolio manager Edemeka likes CenterPoint Energy (CNP), a Houston-based electric and gas utility. The company’s portfolio includes electric transmission and distribution, power generation and gas distribution. It operates in seven states, including Texas.
Edemeka is confident the company can generate earnings per share growth of around 8% through next year, per CenterPoint’s guidance, and at the mid to high end of 6-8% from 2025 through 2030—helped by strong population growth in the Houston area. Its holdings include Houston Electric. “It has one of the highest growth rates in the country,” says Edemeka. “The Texas economy continues to do well.”
Dividends, he says, should grow in line with the company’s earnings.
The stock, which has returned about minus 1% this year, yields 2.6%.
Another of his holdings is NiSource (NI), a large regulated utility based in Indiana. It distributes natural gas and electricity to more than three million customers. Its six-state footprint includes Kentucky, Pennsylvania and Maryland.
The stock, which yields 3.6%, is up about 3% this year. Edemeka calls the company’s earnings guidance of 6% to 8% a year through 2027 “a very realistic outlook with upside potential.”
Travis Miller of Morningstar observed in a note last month that NiSource stock’s yield and what he foresees as a “7% annual earnings growth outlook for the next five years, offer investors what we consider [to be] an attractive total return.”
Miller expects NiSource to close its $2.15 billion minority interest sale of its Indiana utility by the end of this year, “eliminating most financing needs in 2024.”
Utility stocks are down at the moment—but their dividends are far from out.
Write to Lawrence C. Strauss at [email protected]
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