The utility sector is currently undergoing a transition as the primary fuel source, coal, is being replaced by natural gas, and we could notice increased usage of clean energy to produce electricity. The new U.S. administration’s coal friendly moves will definitely lead to some of the coal-based utility plants running for a longer time period than expected.
We advocate that there needs to be a balance between emission control and clean energy generation. A constructive utility rate environment, increase in electricity production from natural gas and renewables, and supporting clean coal-powered projects will enable utilities to efficiently serve a larger customer base.
In the segment below, we discuss the basic strengths of the utility sector.
Stable Demand & Rising Prices
A major positive as well as the most fundamental strength of the utility sector is that there is basically no viable substitute for its services. The endless need for electricity and utility services is a prime driver. This lends revenues and cash flow a high level of stability and visibility.
In a recent release, the U.S. Energy Information Administration (EIA) predicted that the annual average U.S. residential electricity price will increase 2.7% in 2017 and 2.6% in 2018, which will surely benefit the utilities. Electricity prices are also projected to increase in commercial and industrial sector. Per EIA, the total electricity generation will increase 1.04% in 2018 to 11.108 billion Kwh per day. The increase in prices and consumption will no doubt boost earnings of the utilities.
Mergers & Acquisitions
Utility sector operators don’t shy away from merger and acquisition (M&A) activities to supplement organic growth. In addition to giving their operations greater scale and scope, such measures also lead to cost synergies and better utilization of resources. The larger the companies, the more access they have to funds essential for vital infrastructure upgrades.
We believe that in a mature energy market like the United States, M&As represent a sure way of enhancing market share. This expands market reach through the usage of transmission and distribution lines, diversifies the generation portfolio and lowers operating costs through the usage of common back office space.
We are noticing major acquisitions in the water utility space. American Water Works Company (AWK - Free Report) closed several acquisitions in 2017, adding nearly 48,400 customers through acquisitions and organic growth. The pending acquisitions, when closed might increase the company’s customer base by nearly 22,000.
Focus on R&D & Extension of ITC/PTC
In their pursuit of improving the standard of services, utility operators have steadily invested in research and development (R&D). They have introduced new smart meters and strengthened their transmission and distribution lines, which helped in the efficient usage of energy.
Utility operators are also benefiting from the ongoing research in the solar photovoltaic sector. Solar energy is a growing alternate energy source and the new solar cells with higher conversion rates allow operators to generate more power from fewer solar panels. This enables the operators to lower the cost of generating power from alternate sources as these are generally more expensive than fossil fuel sources.
In addition, the utility friendly moves of the U.S. administration through the extension of the validity period of Solar Energy Investment Tax Credit (ITC) and Wind Energy Production Tax Credit (PTC) will help the companies. We will see more utility scale solar and wind projects coming up, which will boost green power generation.
Thanks to the backing from the government, EIA expects wind generation capacity to increase to 88 gigawatts (GW) by the end of 2017 and to 96 GW by the end of 2018 from 81 GW in 2016. EIA expects solar generation capacity to increase to 27 GW by the end of 2017 and to 30 GW by the end of 2018 from 22 GW in 2016.
NextEra Energy (NEE - Free Report) has plans to invest nearly $40 billion to $44 billion in different projects over the 2017-2020 period. The company continues to work on its strategy of making a long-term investment in clean energy assets.
Consistent with the strategy, it announced plans to add nearly 1,400-3,800 MW of solar generation across the United States over the next several years. NextEra Energy’s current renewal energy development program aims at nearly 10,100-16,500 MW of new renewable projects (including wind repowering) online over the 2017–2020 time frame.
Regular Dividend & Share Buybacks
Utility operators generate more or less stable earnings unless there are severe factors disrupting their operations. The regulated nature of operations provides stability. These operators, in turn, reward their shareholders through the payment of sustainable dividends and share buybacks. This was evident during the economic crisis of 2008-2009 when utilities continued to pay dividends uninterruptedly.
We have a long list of companies that are sharing profits consistently with their shareholders. Notable among them are The York Water Company (YORW - Free Report) and CenterPoint Energy (CNP - Free Report) that have raised dividend rates annually for more than 10 years now.
The York Water Company, a Zacks Rank #3 (Hold) stock, increased its quarterly dividend rate by 4% in November 2017 to 16.66 cents. You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.
In December 2017, CenterPoint Energy’s board of directors approved a 3.7% increase in the quarterly dividend rate to 27.75 cents per quarter.
To Sum Up
We notice a transition in the utility sector with more focus on clean energy generation. The relaxed emission regulations under the Trump administration are likely to act as a tailwind for the sector. Stable operations, highly visible revenues and cash flows, combined with the sector’s income/yield attributes are some of its key defining features.
There has been increasing focus on electricity storage facilities that will provide more support to the grid during peak demand period. The utilities are also regularly investing to strengthen their infrastructure to serve customers more efficiently.
The defensive nature and stable performance demonstrated by the utility sector have driven investors to look for a safe haven in this space. In the last 12 months, the sector has returned 6.1% to investors compared with 19.4% gain of the S&P 500. Though the price appreciation is low compared to the S&P 500 peers, staying invested in these regular dividend payers can be a safe investment choice for investors.