The Zacks Utility – Electric Power industry involves the process of generation, transmission, distribution, storage and sale of electricity to residential, commercial and industrial customers. A substantial portion of earnings of these utilities is generated from regulated operations in highly competitive markets. Unless there is substantial weather variation, demand for the services provided by utilities remains more or less steady, regardless of economic cycles. However, the outbreak of the novel coronavirus, followed by lockdown, is expected to lower overall demand for electricity in 2020.
Widely available coal once used to be the key source of electricity in the United States. However, courtesy of the shale gas revolution and conscious efforts toward generating more electricity from clean sources, natural gas gradually replaced coal. Natural gas’ clean burning nature, vast availability and low prices work in its favor. In addition, decline in the cost of setting up utility scale power projects based on renewable energy sources is helping utilities to replace coal from their generation portfolio.
Let's take a look at the industry’s three major themes:
- The outbreak of the novel coronavirus, followed by lockdown to control the spread of the virus adversely impacted demand for electricity. The U.S. Energy Information Administration (EIA) forecasts 5.7% reduction of electricity consumption in the United States compared with the 2019 level. Decline in demand from commercial and industrial customer group due to lockdown is the primary reason for reduction in consumption. Electricity demand from commercial and industrial customers is expected to decline 9.1% and 6.7% respectively from the 2019 level. Per EIA, demand from residential space is expected to drop 1.5% in 2020, primarily due to milder temperature lowering electricity consumption for space heating and cooling. However, stay-at-home directives to control the spread of the virus are expected to push up demand from residential group and marginally offset the reduction in demand.
- A transition in the U.S. utility space in quite evident with more operators voluntarily announcing long-term plans to go carbon neutral or lower emission substantially from historical levels. Utilities are gradually moving away from coal and have started to focus on clean natural gas and renewable sources to generate electricity. EIA forecasts renewable sources to contribute 21% of the U.S. electricity production in 2020 up from 17% in 2019. The share of natural gas will be 41% in 2020, up from 37% in 2019. Both renewable energy and natural gas continue to eat away the share of coal in electricity generation, which is expected to average 17% in 2020, down from 24% in 2019.
- EIA forecasts that renewable energy will be the fastest-growing source of electricity generation in 2020.However, a major drawback of clean renewable sources is the inability to produce 24x7 power like fossil fuel-based electricity plants due to natural causes. The ongoing research and development have significantly reduced cost of producing electricity from solar and wind power. EIA expects the electric power sector to add 23.2 gigawatts of new wind capacity and 12.6 gigawatts of utility-scale solar capacity in 2020. To overcome no production from renewable sources, utility scale battery storage is being installed in large scale in the United States. Per the International Renewable Energy Agency, at present utility-scale stationary batteries’ projects will dominate global energy storage. Per Navigant Research’s finding, U.S. annual energy storage projects are expected to touch 1,400 MW in 2020 and increase to more than 4,000 MW in 2023. The use of advanced technology, and ongoing research and development will further lower the cost of installing utility scale battery storage project and assist in the transition toward clean energy.
Zacks Industry Rank Indicates Bleak Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates weak near-term prospects. The 63-stock Utility - Electric Power industry is housed within the broader Utilities Sector and currently carries a Zacks Industry Rank #150, which places it in the bottom 41% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts have lost confidence in this group’s earnings growth potential. Since March 2020, the industry’s earnings estimates for the current year have been revised downward by 2% to $2.90.
Before we present a few Utility - Electric Power stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and current valuation.
Industry Lags S&P 500, Tops Sector
The Utility Electric Power industry has outperformed its own sector but lagged the Zacks S&P 500 composite over the past 12 months.
The industry has lost 7.2% compared with its sector’s decline of 21.4% and the Zacks S&P 500 composite’s increase of 7% in the period.
One-Year Price Performance
Industry’s Current Valuation
On the basis of EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) TTM, which is a commonly used multiple for valuing Utility Electric Power companies, the industry is trading at 11.77X compared with the S&P 500’s 11.61X and the Utilities sector’s 18.06X.
Industry EV/EBITDA TTM vs S&P 500
Industry EV/EBITDA TTM vs Sector
In the past five years, the industry has traded as high as 13.6X, as low as 7.81X, with a median of 10.36X.
To Sum Up
Capital-intensive Utility companies are concerned about the continued increase in interest rates. However, in March 2020, the Federal Reserve lowered interest rates to the near-zero level in order to boost U.S. economic growth and is expected to keep it at low levels till 2022. Low interest rates will be a blessing for the utilities as it will provide access to low-cost funding for infrastructure development and give them an opportunity to refinance old debts with proceeds from low-interest bearing debts.
The outbreak of the novel coronavirus has resulted in an unprecedented economic crisis, putting millions of Americans in financial distress. In such a condition, utilities have ensured 24x7 electricity supply to every customer even they fail to clear their service dues. The utilities also assisted their customers with flexible payment options to clear dues. The demand for electricity in 2020 is expected to drop due to the pandemic but, per EIA, will likely increase by 1% in 2021.
Moreover, cost control, new electric rates and customer growth should continue to help the players maintain operational stability. The utility industry being a mature one has a quite a few members in the S&P 500 group. Below we present a few S&P 500 stocks from the Utility Electric Power industry that have been witnessing positive earnings estimate revisions.
NextEra Energy Inc. (NEE - Free Report) sporting a Zacks Rank #1 (Strong Buy), is headquartered in Juno Beach, FL. This utility has gained 18% over the past 12 months. The Zacks Consensus Estimate for current-year EPS has inched up 0.2% over the past 30 days to $9.08. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Price and Consensus: NEE
Dominion Energy Inc. (D - Free Report) , a Zacks Rank #3 stock, is headquartered in Richmond, VA. This utility has gained 5.2% over the past 12 months. The Zacks Consensus Estimate for current-year EPS has inched up 0.5% over the past 30 days to $4.33.
Price and Consensus: D
Eversource Energy (ES - Free Report) , a Zacks Rank #3 stock, is headquartered in Springfield, MA. This utility has gained 8.3% over the past 12 months. The Zacks Consensus Estimate for current-year EPS has remained same at $3.64 in the past 30 days.
Price and Consensus: ES
WEC Energy Group (WEC - Free Report) , a Zacks Rank #3 stock, is headquartered in Milwaukee, WI. This utility has gained 2.6% over the past 12 months. The Zacks Consensus Estimate for current-year EPS has remained the same in the past 30 days at $3.73.
Price and Consensus: WEC