Beyond The Dividends

11/14/2016


Investors tend to flock to utility stocks for the fat dividend yields, with operating momentum often little more than an afterthought. However, unusually low interest rates, combined with industry regulations, are helping utilities generate decent growth.

Low interest rates benefit utilities on several fronts. First, their shares look especially attractive to yield-starved investors. Secondly, their operations benefit from lower borrowing costs.

Utilities have significant incentives to expand, and it's rarely been cheaper for them to do so. Regulators cap the rate of return utilities can make on their rate base, which is the value of the assets a utility uses to provide service to customers. This policy gives utilities a motive to increase their rate base — more assets, more income. Duke Energy ($77; DUK) has said that every $1 billion increase to its rate base boosts profits by $0.08 per share.

However, mandated rates of return set by regulators have not been sufficiently lowered to reflect the unusually cheap borrowing environment. In addition, utility shares have performed well in recent years, allowing the companies to raise capital more cheaply via stock offerings.

Against this backdrop, S&P 1500 utilities grew capital spending an average of 8% in 2015, the most recently available data for the majority of these companies, as shown in the table below.

Cap-ex ramps for S&P 1500 utilities
S&P 1500
Utilities
Average
(%)
S&P 1500
Index
Average
(%)
S&P 1500
Utilities
Rank (11
Sectors)
Earnings per share
1-year change
2
5
9
3-year annual. chg.
3
7
8
Operating profit
1-year change
4
3
4
3-year annual. chg.
5
7
7
Sales
1-year change
(6)
3
10
3-year annual. chg.
0
5
9
Share count
1-year change
2
0
3
3-year annual. chg.
6
1
5
Capital spending
1-year change
8
0
2
3-year annual. chg.
5
6
8

Sales growth still tends to be elusive for utilities, and gains in per-share profits often negligible. On average, the S&P 1500's utilities grew per-share profits 2% over the last year, lagging the 5% average for the broad index. But utilities' operating profits have risen an average of 4% over the past 12 months, ahead of the index's 3% gain. The discrepancy between the sector's growth for earnings per share and operating profits may be partly explained by utilities issuing shares at an accelerated rate, thus diluting profits. The share count for the average S&P 1500 utility is up 2% in the past year, while index stocks as a group average a flat share count.

While utilities are outgrowing the market at the moment, their profit growth has historically lagged, with the S&P 1500 Utility Sector Index managing profit growth of 1% annualized over the last 20 years, versus 5% for the full index. Don't expect utilities to become tomorrow's growth leaders.  

The sector faces several headwinds. Alternative energy, currently accounting for 13% of U.S. electricity generation, could gradually take share from traditional utilities. Energy-efficiency improvements could also limit demand growth.

Additionally, sharply higher interest rates could produce a doubly painful effect for utilities, as income investors move on to other assets and borrowing costs become higher. However, the Federal Reserve's path toward higher interest rates seems likely to remain slower and shallower than that seen in previous economic cycles.

TOP 15 UTILITIES
YTD
Total
Return
(%)
12-Month
--- Change ---
Capital
Expenditures
1-Year
Share-
Count
Chg.
(%)
Company (Price; Ticker)
Div.
Yield
(%)
Per-
Share
Profit
(%)
Oper.
Profit
(%)
Trailing
P/E
Ratio
2015
($)
2015
Chg.
(%)
Quadrix
Overall
Score
Allete ($59; ALE)
3.5
20
(11)
(8)
19
287
(50)
1
51
Atmos Energy
($72; ATO)
2.3
16
7
8
22
975
17
2
37
Avista ($41; AVA)
3.4
19
14
14
20
394
19
3
42
CONE Midstream
($20; CNNX)
5.2
119
103
103
13
291
8
0
98
Entergy ($69; ETR)
5.1
5
59
58
8
2,941
14
0
57
EQT Midstream
($71; EQM)
4.6
(2)
13
33
13
409
101
13
99
Otter Tail
($36; OTTR)
3.5
39
0
2
23
160
(2)
3
68
Portland General
($43; POR)
3.0
20
2
10
21
598
(41)
0
52
Public Service
Ent. ($41; PEG)
4.0
8
(22)
(22)
14
3,863
37
0
54
SJW ($49; SJW)
1.7
68
89
90
20
107
5
0
86
Star Gas Partners
($10; SGU)
4.3
36
3
3
13
10
5
0
77
UGI ($45; UGI)
2.1
36
60
60
21
491
7
0
77
Unitil ($42; UTL)
3.4
20
(2)
(1)
22
104
12
1
69
Vectren ($49; VVC)
3.3
19
15
15
20
477
6
0
56
WGL Holdings
($62; WGL)
3.2
1
9
8
20
464
18
2
70
Note: Quadrix scores are percentile ranks, with 100 the best.

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