AEP, Duke Energy, and other utility stocks to weather a recession

  • By Lawrence C. Strauss,
  • Barron's
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Utilities have been one of the top-performing sectors in the S&P 500 () during a difficult stretch for stocks overall, returning nearly 5% over the 12-month period ended Jan. 6., including dividends.

It might not sound like much, but it is a lot better than most of the other S&P sectors. The S&P 500 itself is off by about 16% over that time.

A 2023 UBS outlook note last month expects “utilities to outperform in the [first half] on defensive versus cyclical rotation and growth & yield-focused fund flows driven by recession fears.” It added that since 1972, utilities have outperformed the S&P 500 by an average of 5.5 percentage points in the quarter prior to recessions.

For this screen, Barron’s took a basic approach: utilities in the S&P 500 with yields above 2.5%, a positive return in 2022, and a market capitalization above $40 billion.

Five companies made the cut: American Electric Power (), Southern (), Duke Energy (), Sempra Energy (), and Exelon ().

Investors need to keep in mind that utilities, by and large, aren’t cheap. Those in the S&P 500 fetch about 19 times their forward 12-month profit estimates, well above their 20-year average of 15.5 times, according to Morgan Stanley.

Another downside is that utility stocks have lost their yield advantage over many bonds as interest rates have surged higher.

Investors are no doubt paying up for what they believe will be solid and sustainable earnings growth. Andrew Bischof, utilities strategist at Morningstar, expects the companies in his coverage area to grow earnings by an average annual clip of 6% over the next five years.

That will be helped by the transition to clean energy and the increased demand for electricity that creates. “You really haven’t seen significant electricity growth in the past decade or so, and we think that’s going to change,” he says.

Stephanie Link, chief investment strategist and portfolio manager at Hightower Advisors, likes American Electric Power in particular, its valuation notwithstanding.

It changes hands at around 18 times FactSet’s consensus 2023 profit estimate of $5.30 a share. “I like the geographic diversification and cash-flow stability,” Link says.

Based in Columbus, Ohio, the company has regulated operations that stretch across several Midwestern states; Kentucky, West Virginia, and Virginia; as well as Texas, Oklahoma, Louisiana, and Arkansas.

Regulated utility operations such as generation plants are subject to rate approvals from government regulators, an arrangement that investors often like because it can provide financial stability.

The company’s capital spending includes regulated power transmission and regulated renewable energy assets, Link says, adding, that “both should lead to higher returns and faster growth.”

The stock yields 3.4%.

Southern, based in Atlanta, generates and sells electricity. Its subsidiaries include power companies in Georgia, Alabama, and Mississippi, giving it a strong footprint in the Southeastern U.S.

This stock, which yields 3.8%, isn’t cheap either, trading at about 19 times its FactSet profit estimate of $3.75 a share.

UBS noted that “the company is on track to complete construction of the Vogtle nuclear plant in 2023 and the risk premium in [the] shares should wane.” It was referring to a construction project in Georgia that has had delays and cost overruns, according to Morningstar.

Shares of Charlotte, N.C.-based Duke Energy are in a similar valuation range, changing hands at about 18.7 times their consensus 2023 profit estimate.

The company’s operations include electric utilities, natural gas distribution, and developing clean energy. It has positioned itself adroitly in regulated utility markets such as Florida and North Carolina, says Bischof.

“It’s a much cleaner story going forward with a good growth profile,” he says, adding that the company should be able to grow its earnings at a 6% annual clip. “Management just has to be able to execute on that plan.”

The stock yields 3.8%. The consensus FactSet 2023 profit estimate is $5.68 a share, up about 7% year over year.

Sempra Energy, based in San Diego with big operations in California and Texas, was recently yielding 3.0%. Its stock fetches about 17.5 times the $8.99 it is expected to earn this year, a little cheaper than some of the other stocks in this screen.

The company’s businesses include generating and distributing electricity and gas through regulated utilities, along with energy infrastructure such as a stake in a natural gas liquefaction export facility in Louisiana.

“Sempra Energy’s investment opportunities at its regulated utilities in California and Texas will remain the primary growth driver,” Bischof observed in a research note.

The other company that made the cut is Exelon, a Chicago-based holding company with major operations such as the utilities Commonwealth Edison and PECO Energy (Philadelphia). The stock yields 3.1%.

It trades at about 18.7 times its consensus FactSet 2023 earnings estimate of $2.36 per share.

Based on the calculations of Mizuho Securities USA analysts, the stock recently traded at a slight discount to the group but “it has an attractive 6-8% EPS growth rate,” according to a Jan. 9 note.

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