Even though utilities stocks have rallied recently, many are lagging the market this year—despite solid dividends and durable earnings. That makes them attractive for yield hunters.
“By and large, your rank-and-file utility not only has increased the dividend this year, but nobody’s really taken down their earnings estimates for this year,” says John Bartlett, a portfolio manager and analyst at Reaves Asset Management, which specializes in utilities and infrastructure investments.
The earnings estimate for the Utilities Select Sector SPDR exchange-traded fund (XLU) is down about 3% from where it was in late February, according to FactSet—hardly a big drop when compared to more volatile sectors such as energy.
As of Oct. 20, that ETF had returned about 1.5% in 2020, compared with 8.2% for the S&P 500 index (.SPX). In the past month, however, the ETF has returned nearly 11%, besting the broader index’s result of about 5%.
Lindsey Bell, chief investment strategist at Ally Invest, says that “the interest in utilities more recently reflects a defensive move by market participants ahead of the election.” She adds that “utilities provide a solid dividend and more stability than other sectors in that type of environment.”
The utilities in the S&P 500 were recently yielding about 3.2%, compared with 2.7% for consumer staples—another popular sector for income investors.
Utility stocks have also suffered because of what they are not—fast-growing companies in tech and other sectors that have been popular among investors this year. The stocks are also weighed down as investors look ahead to next year’s earnings estimates in the various sectors.
“While the S&P 500 should see 25% growth, utilities will likely eke out only a 3.5% advance,” says Sam Stovall, chief investment strategist at CFRA. On the plus side, utilities trade at a 23% discount to their 20-year average, based on estimated profits over the next 12 months, he notes.
Still, the sector isn’t dirt cheap based on more recent history. The Utilities Select Sector SPDR ETF fetches about 19 times 2021 earnings estimates—down from 21.6 times in February but above the five-year average of around 17.3 times, according to FactSet.
Utility stock performance has been very uneven during the pandemic.
NextEra Energy (NEE), whose businesses include the Florida Power & Light utility as well as a big renewable energy portfolio, is “in a class of its own,” says Reaves’ Bartlett.
NextEra is on a roll. Bucking the overall trend for the sector, it was up 26% as of Oct. 20, dividends included. The stock yields 1.8%. Based on a 4-for-1 stock split effective on Oct. 26, the company’s quarterly dividend is 35 cents a common share.
But there’s no shortage of yield elsewhere in the sector, along with some downside protection.
“The average utility is going to be able to grow its earnings 5% or so a year, year in year out, without regard to what’s going on in the economy,” says Bartlett. “[And] so if you’re jittery and looking for a more conservative alternative, that’s the story.”
Reaves oversees about $3 billion of assets, including the $1.6 billion Reaves Utility Income fund (UTG). As of Sept. 30, NextEra was its largest holding.
The closed-end fund’s 2020 total return was about minus 8% as of Oct. 20, according to Morningstar. The fund ranks in the top 20% of its Morningstar category year to date.
After NextEra, Bartlett says, there’s a group of quality utilities that have benefited from investors seeing “great stability in their earnings.” Those include WEC Energy Group (WEC), a Milwaukee-based firm that generates and distributes electricity and natural gas; Xcel Energy (XEL), whose businesses include generating and distributing electricity; and Eversource Energy (ES). Based in Springfield, Mass., Eversource handles electricity, natural gas, and water.
the accompanying table shows, the stocks of all three companies have had respectable returns this year.
Two other utility stocks held by Reaves include Michigan-based CMS Energy (CMS) and Alliant Energy (LNT), a Wisconsin-based firm. Both stocks yield well above 2%. These companies, says Bartlett, should benefit from cost cutting and investing in renewable energy projects, among other factors.
Bartlett also holds some gas distribution companies, a group that’s faced stiff headwinds.
“There’s a constituency of people that don’t want anything having to do with the carbon atom, and these companies are in the business of delivering carbon atoms,” he says.
He agrees that renewable energy is gaining traction, but asserts that “we need gas, and it’s not going away.”
One such holding is Atmos Energy (ATO), which is based in Dallas and whose stock yields 2.4%. Its return this year is about minus 14%. Analysts polled by FactSet expect the company to earn $4.71 a share in its most recent fiscal year, which ended last month, versus $4.35 in the previous year.
Another beaten-down holding is New Jersey Resources (NJR), whose portfolio includes a clean-energy business dedicated to commercial and residential solar power. The company is expected to earn $2.06 in its most recent fiscal year, which ended last month, versus $1.96 in the prior year.
The stock is down more than 30% year to date, but last month the company’s board declared a quarterly dividend of 33.25 cents a share, up 6%.
“A lot of people really pay up too much for yield,” says Bartlett. “And really it’s more about the stability of income at this point than the actual coupon.”
Utilities, for the most part, continue to check that box.
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