Five Facts About Utilities

5/8/2017


Utilities are like political parties. You either love them or hate them.

No other market sector can match utilities for inspiring polarizing feelings among investors. Some love the stability and dividends that utilities provide, while others see subpar growth and look elsewhere.

Here at the Forecasts, we try to see both sides of the argument — and an objective look at utilities can find ample reason to join either camp. Below we present five facts about utility stocks every investor should know:

1) Investors who claim utility stocks can't match the growth of the rest of the market have a point. Over the last three years, utility stocks in the S&P 1500 Index averaged annualized sales growth of 0% and per-share-profit growth of 4%, well below the respective averages of 6% and 8% for all stocks in the index. What it means: The business models of most utilities limit expansion, and regulatory requirements limit the profitability of their core units.

2) While utilities tend to lag during upward markets, over the long haul they have delivered competitive returns. Over the last decade, the S&P 1500 Utility Sector Index managed an annualized total return of 7.0%, versus 7.3% for the broader index. In the decade before that, utilities outperformed. What it means: Don't assume that because utilities tend to generate less growth, they'll necessarily underperform. Of course, utilities will have a harder time keeping pace in an environment of rising interest rates. 

3) Utility stocks have below-average fundamentals, but don't look terrible. Utilities average Quadrix Overall scores of 55, versus 59 for the broad index. Utilities tend to lag in Momentum (operating growth for periods of up to a year) and Quality (long-term growth and returns on equity, investment, and assets) — though at the moment their Momentum scores exceed the index average. What it means: In part because of their slower growth, utilities tend to earn unimpressive Quadrix scores. This is especially true at the top, as just two of the index's 54 utilities score 80 or higher Overall.

4) Utility shares are less volatile than most. We looked at volatility using standard deviation of monthly returns over the last five years. Utility stocks averaged 5%, well below the average of 8% for all index stocks. What it means: As a group, utilities are less likely to provide whipsaw returns — though some individual utilities are quite volatile.

5) Investors may expect utilities to trade at a discount because of their low growth, and they do — kind of. The average utility stock in the S&P 1500 trades at 20.5 times trailing earnings, versus 22.8 for the index as a whole. However, in a somewhat pricey market, utilities average a premium of 12% to their five-year average valuation, twice the premium of the typical index stock. What it means: Utilities have historically traded at a discount to the average stock, but that discount has narrowed in recent years.

Whether you love or hate utilities, it may make sense to own some, if only to diversify your portfolio. Currently, no utility stocks offer the mix of growth, value, and fundamental strength needed to make it onto our recommended lists. Instead, we recommend investors purchase our Top 15 Utilities portfolio, presented in the table below.

This week, we're making a change to the portfolio, with NextEra Energy ($133; NEE) replacing Public Service Enterprise Group ($44; PEG). We address that move and profile an additional stock from the portfolio in the following paragraphs:

NextEra Energy serves nearly 5 million electricity customers in Florida. The company also operates a nonregulated power unit, the largest U.S. generator of wind and solar power. While NextEra owns one of the largest collections of nuclear plants in America, those plants account for just 23% of NextEra's energy mix, with 70% coming from natural gas.

NextEra beat March-quarter profit targets, earning $1.75 per share, up 10% excluding special items and $0.19 above the consensus. In response, full-year estimates are rising. The consensus now calls for profit growth of 8% this year. For context, the typical utility is expected to grow profits 2%. At 20 times expected 2017 profits, NextEra trades 6% above the industry median, a premium well warranted by its superior growth potential.

The company raised its dividend 13% this year and plans another hike of that size or larger next year, an aggressive path for any firm, let alone a utility. NextEra earns an A rating on our Monitored List and is joining the Top 15 Utilities portfolio.


Public Service Enterprise Group earns the lowest Quadrix Overall score (36) in the Top 15 Utilities portfolio, and both of its sector-specific scores have dipped below 35. Blame the weak scores on an erosion of operating momentum and weak profit-estimate trends.

The shares look cheap relative to peers — a discount that reflects the company's below-market growth. Public Service Enterprise has invested heavily in infrastructure in recent years, untapped growth that helped the stock retain its place in the Top 15 Utilities portfolio despite subpar Quadrix scores. But this company has kept us waiting too long. Its replacement, NextEra, is delivering the growth now. Public Service Enterprise is being dropped from the Top 15 Utilities portfolio and now earns a B (average) in our Utility Update. The stock was never on the Monitored List.


UGI ($49; UGI) is more than a utility. Yes, it distributes gas and electricity to more than 620,000 customers, mostly in Pennsylvania. But UGI's utility and midstream natural-gas operations combine to account for about half of its profits — the rest comes from propane businesses in the U.S. and Europe.

In the March quarter, per-share profits rose 6% to $1.31 excluding special items, a penny below the consensus, on a 4% rise in revenue. Efficiency improvements and an increase in natural-gas utility rates nearly offset the effects of an unusually warm winter in all of UGI's markets. Citing the weather, which crimped both propane and gas-utility profits, UGI projects full-year per-share earnings of $2.30 or slightly below, lagging the $2.42 consensus for the year ending September.

While the guidance is disappointing, UGI may be sandbagging, as it has already earned $2.22 in the first two quarters of the year. Regardless, at 20 times trailing earnings, the shares trade at a 21% discount to the industry median, a valuation that leaves plenty of room for a rally if UGI can deliver even modestly good news. UGI is part of our Top 15 Utilities portfolio and earns an A (above average) rating on our Monitored List.

TOP 15 UTILITIES PORTFOLIO
Our Top 15 Utilities portfolio is designed to provide a yield comparable to that of the typical utility, with greater total-return potential. To follow the Top 15, use the money you would normally devote to utilities to purchase equal-dollar amounts of all 15 stocks.
---- P/E Ratio ----
----------------------------- Quadrix Scores -----------------------------
Company (Price; Ticker)
Div.
($)
Yield
(%)
Trailing
Premium
To 5-Yr.
Average
(%)
Momen-
tum
Value
Quality
Overall
12-
Factor
Sector
Reranked
Overall
Atmos Energy ($80; ATO)
1.80
2.2
23
18
58
41
58
52
52
34
Edison International ($79; EIX)
2.17
2.8
19
18
92
54
60
77
78
90
Entergy ($76; ETR)
3.48
4.6
11
(7)
10
76
15
32
40
28
EQT Midstream Part. ($76; EQM) *
3.56
4.7
14
(31)
49
82
94
92
39
100
Eversource Energy ($59; ES)
1.90
3.2
20
9
67
63
50
60
73
76
Great Plains Energy ($29; GXP)
1.10
3.8
16
(10)
83
74
45
74
91
96
NextEra Energy ($133; NEE)
3.93
2.9
21
12
75
56
65
77
67
88
Portland General ($45; POR)
1.36
3.1
19
10
55
65
47
63
87
82
Scana ($65; SCG)
2.45
3.8
16
1
58
74
50
58
57
58
SJW Group ($48; SJW)
0.87
1.8
22
10
59
51
77
63
7
46
Star Gas Partners ($9; SGU) *
0.44
4.8
14
(6)
22
81
71
62
49
63
UGI ($49; UGI)
1.00
2.1
20
10
36
68
68
59
85
70
Unitil ($48; UTL)
1.44
3.0
23
16
61
49
39
54
81
66
Vectren ($59; VVC)
1.68
2.9
23
15
59
49
56
53
75
55
WGL Holdings ($82; WGL)
2.04
2.5
25
17
53
39
56
50
84
37
Portfolio average
3.2
19
6
56
61
57
62
64
66
Avg. for utilities in S&P 1500
3.1
21
12
58
57
44
53
54
53
Note: Quadrix scores are percentile ranks, with 100 the best.     * Master limited partnership (MLP).

 


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