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Though utility companies are among the safest investment bets, they have their share of weaknesses. Regulatory burdens, weather variation and increased debt loads are major concerns. While the Trump administration is expected to lower the industry’s regulatory burden, an even bigger issue is the interest rate backdrop.
The Fed raised interest rates for three consecutive quarters (December 2016, March 2017 and June 2017), which is a drag for rate-sensitive sectors like Utilities. Making things worse, the Fed might hike interest rates again in December, if economic conditions remain conducive.
Let’s look into the factors which might deter investors from investing in the utility space.
Debt Levels & Rising Rates
Utilities are capital intensive and need to have a continuous inflow of funds to maintain organic growth and infrastructure upgrade projects. This is essential for maintaining an uninterrupted supply of basic amenities like electricity, fresh water and gas.
Utilities generate funds from operations which are to some extent used to meet their capital requirements. But these funds are mostly used for dividend payouts. They take recourse to external sources of financing to meet their capital requirements.
We believe that a rising interest rate environment could add to the woes of utility operators, as it will increase cost of capital, restraining their ability to pay consistent dividends. We suggest that investors take note of outstanding debts and current ratio, both of which indicate the company’s ability to meet its debt obligations.
Weather a Headwind
Weather plays a vital role in driving demand for utility services. A normal winter and summer season assure higher demand for utility services. However, a milder winter and a cooler summer results in lower demand for utility services.
The Electric Reliability Council of Texas (ERCOT) in its recent release announced that since Hurricane Harvey hit the land, demand for electricity in Texas dropped to 20,000 megawatts (MW) per day, down from typical August demand of 44,000 MW, primarily due to structural damage and cooler temperature in the affected region.
We believe that the drop in demand, power outages and structural damage will impact the third-quarter earnings goal of American Electric Power (NYSE:(AEP - Free Report) – Free Report), CenterPoint Energy Inc. (NYSE:(CNP - Free Report) – Free Report) and Entergy Corporation (NYSE:(ETR - Free Report) – Free Report), having operations in the region.
Hurricane Irma, a Category Five storm currently progressing toward Florida, could cause vast damage to utility infrastructure.
Competition with Bonds
These reliable dividend payers are in competition with bonds as an investment option. The ongoing increase in interest rates will definitely make bonds with its yields another attractive investment option for risk-averse investors, driving them away from the utility space.
The Fed has increased the interest rate three times in the last three quarters, which will raise the cost of capital for the utilities and might adversely impact its ability to carry on with dividend payment and share buyback, making the high interest-bearing bonds a more alluring option for investors.
Safe But Limited Growth Potential
Investment in these highly regulated defensive utilities is considered safe. Even though utilities pay regular dividends and go for buybacks, the scope of capital appreciation is quite limited for investors in this space. Share prices in this sector do not jump the way they do in the technology sector, so the returns are never dramatic.
Utilities to Avoid for the Time Being
We presently recommend investors to stay away from the following utilities having an unfavorable Zacks Rank. The other metrics also indicate that these utilities are not profitable investment options now.
Westar Energy currently has a Zacks Rank #4 (Sell). It saw an average negative surprise of 7.75% for the last four quarters. The Zacks Consensus Estimate for 2017 earnings per share declined 0.4% in the last 90 days to $2.50. Westar has lost 9.3% year to date versus 10.2% rally of the Zacks Electric Power industry it belongs to.
Global Water Resources Inc. (NASDAQ:(GWRS - Free Report) – Free Report) saw an average negative surprise of 50% for the last four quarters. The Zacks Consensus Estimate for 2017 earnings per share has decreased 36.4% over the last 90 days to 7 cents. The company currently has a Zacks Rank #4. Global Water Resources stock has gained 3.4% year to date, much lower than Zacks Water Supply industry’s gain of 10.3%.
Bottom Line
We believe that focus on clean energy is going to be at the top of the utility companies agenda in the coming years. We expect utilities to take advantage of the shale boom in the United States and falling prices to develop power plants based on natural gas and renewable source of energy. Combined-cycle natural gas power plants not only help to lower pollution but also result in energy efficiency.
We expect President Trump’s view on climate change and plans to abandon the Paris agreement to be support fossil fuel-based companies and help them survive the ongoing challenges. A makeover in the utility space is already underway, but the decision to repeal the Clean Power Plan will help the utilities continue with the coal-fired units for longer than previously expected. The crucial question is, will the ongoing hike in interest rate offset the benefits of a favorable decision of the new administration?
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Many are little publicized and fly under the Wall Street radar. They're virtually unknown to the general public. Yet today's 220 Zacks Rank #1 "Strong Buys" were generated by the stock-picking system that has nearly tripled the market from 1988 through 2015. Its average gain has been a stellar +26% per year.See these high-potential stocks free >>.
Zacks Investment Research is under common control with affiliated entities (including a broker-dealer and an investment adviser), which may engage in transactions involving the foregoing securities for the clients of such affiliates.
Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Zacks Investment Research does not engage in investment banking, market making or asset management activities of any securities. These returns are from hypothetical portfolios consisting of stocks with Zacks Rank = 1 that were rebalanced monthly with zero transaction costs. These are not the returns of actual portfolios of stocks. The S&P 500 is an unmanaged index. Visit https://www.zacks.com/performancefor information about the performance numbers displayed in this press release.
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Zacks Industry Outlook Highlights: American Electric Power, CenterPoint Energy, Entergy and Global Water Resources
For Immediate Release
Chicago, IL – September 11, 2017 – Today, Zacks Equity Research discusses the Industry: Utilities, Part 3, including American Electric Power (NYSE:(AEP - Free Report) – Free Report), CenterPoint Energy Inc. (NYSE:(CNP - Free Report) – Free Report), Entergy Corporation (NYSE:(ETR - Free Report) – Free Report) and Global Water Resources Inc. (NASDAQ:(GWRS - Free Report) – Free Report).
Industry: Utilities, Part 3
Link: https://www.zacks.com/commentary/127761/rising-interest-rates-make-life-tough-for-utilities
Though utility companies are among the safest investment bets, they have their share of weaknesses. Regulatory burdens, weather variation and increased debt loads are major concerns. While the Trump administration is expected to lower the industry’s regulatory burden, an even bigger issue is the interest rate backdrop.
The Fed raised interest rates for three consecutive quarters (December 2016, March 2017 and June 2017), which is a drag for rate-sensitive sectors like Utilities. Making things worse, the Fed might hike interest rates again in December, if economic conditions remain conducive.
Let’s look into the factors which might deter investors from investing in the utility space.
Debt Levels & Rising Rates
Utilities are capital intensive and need to have a continuous inflow of funds to maintain organic growth and infrastructure upgrade projects. This is essential for maintaining an uninterrupted supply of basic amenities like electricity, fresh water and gas.
Utilities generate funds from operations which are to some extent used to meet their capital requirements. But these funds are mostly used for dividend payouts. They take recourse to external sources of financing to meet their capital requirements.
We believe that a rising interest rate environment could add to the woes of utility operators, as it will increase cost of capital, restraining their ability to pay consistent dividends. We suggest that investors take note of outstanding debts and current ratio, both of which indicate the company’s ability to meet its debt obligations.
Weather a Headwind
Weather plays a vital role in driving demand for utility services. A normal winter and summer season assure higher demand for utility services. However, a milder winter and a cooler summer results in lower demand for utility services.
The Electric Reliability Council of Texas (ERCOT) in its recent release announced that since Hurricane Harvey hit the land, demand for electricity in Texas dropped to 20,000 megawatts (MW) per day, down from typical August demand of 44,000 MW, primarily due to structural damage and cooler temperature in the affected region.
We believe that the drop in demand, power outages and structural damage will impact the third-quarter earnings goal of American Electric Power (NYSE:(AEP - Free Report) – Free Report), CenterPoint Energy Inc. (NYSE:(CNP - Free Report) – Free Report) and Entergy Corporation (NYSE:(ETR - Free Report) – Free Report), having operations in the region.
Hurricane Irma, a Category Five storm currently progressing toward Florida, could cause vast damage to utility infrastructure.
Competition with Bonds
These reliable dividend payers are in competition with bonds as an investment option. The ongoing increase in interest rates will definitely make bonds with its yields another attractive investment option for risk-averse investors, driving them away from the utility space.
The Fed has increased the interest rate three times in the last three quarters, which will raise the cost of capital for the utilities and might adversely impact its ability to carry on with dividend payment and share buyback, making the high interest-bearing bonds a more alluring option for investors.
Safe But Limited Growth Potential
Investment in these highly regulated defensive utilities is considered safe. Even though utilities pay regular dividends and go for buybacks, the scope of capital appreciation is quite limited for investors in this space. Share prices in this sector do not jump the way they do in the technology sector, so the returns are never dramatic.
Utilities to Avoid for the Time Being
We presently recommend investors to stay away from the following utilities having an unfavorable Zacks Rank. The other metrics also indicate that these utilities are not profitable investment options now.
Westar Energy currently has a Zacks Rank #4 (Sell). It saw an average negative surprise of 7.75% for the last four quarters. The Zacks Consensus Estimate for 2017 earnings per share declined 0.4% in the last 90 days to $2.50. Westar has lost 9.3% year to date versus 10.2% rally of the Zacks Electric Power industry it belongs to.
Global Water Resources Inc. (NASDAQ:(GWRS - Free Report) – Free Report) saw an average negative surprise of 50% for the last four quarters. The Zacks Consensus Estimate for 2017 earnings per share has decreased 36.4% over the last 90 days to 7 cents. The company currently has a Zacks Rank #4. Global Water Resources stock has gained 3.4% year to date, much lower than Zacks Water Supply industry’s gain of 10.3%.
Bottom Line
We believe that focus on clean energy is going to be at the top of the utility companies agenda in the coming years. We expect utilities to take advantage of the shale boom in the United States and falling prices to develop power plants based on natural gas and renewable source of energy. Combined-cycle natural gas power plants not only help to lower pollution but also result in energy efficiency.
We expect President Trump’s view on climate change and plans to abandon the Paris agreement to be support fossil fuel-based companies and help them survive the ongoing challenges. A makeover in the utility space is already underway, but the decision to repeal the Clean Power Plan will help the utilities continue with the coal-fired units for longer than previously expected. The crucial question is, will the ongoing hike in interest rate offset the benefits of a favorable decision of the new administration?
4 Surprising Tech Stocks to Keep an Eye On
Tech stocks have been a major force behind the market’s record highs, but picking the best ones to buy can be tough. There’s a simple way to invest in the success of the entire sector. Zacks has just released a Special Report revealing one thing tech companies literally cannot function without. More importantly, it reveals 4 top stocks set to skyrocket on increasing demand for these devices. I encourage you to get the report now – before the next wave of innovations really takes off.
See Stocks Now>>
Strong Stocks that Should Be in the News
Many are little publicized and fly under the Wall Street radar. They're virtually unknown to the general public. Yet today's 220 Zacks Rank #1 "Strong Buys" were generated by the stock-picking system that has nearly tripled the market from 1988 through 2015. Its average gain has been a stellar +26% per year.See these high-potential stocks free >>.
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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Zacks Investment Research does not engage in investment banking, market making or asset management activities of any securities. These returns are from hypothetical portfolios consisting of stocks with Zacks Rank = 1 that were rebalanced monthly with zero transaction costs. These are not the returns of actual portfolios of stocks. The S&P 500 is an unmanaged index. Visit https://www.zacks.com/performancefor information about the performance numbers displayed in this press release.