We are fast approaching the end of Q4 Earnings season, with earnings from 375 of the S&P 500 members already out as of Feb 15. The earnings results are good so far with earnings from the 375 index members up +7.2% on the back of +4.6% higher revenues.
Taking into account the remaining 25% of the index members, the overall, S&P 500 earnings are expected to be up 7.4% on 3.9% higher revenues, with growth expected in the positive territory for 12 of the 16 Zacks sectors.
Let’s Focus on the Utilities
Amid this positive backdrop, let us focus on the domestic focused mature Utility sector. Only 33% of the Utilities in the S&P 500 group have reported their earnings as of Feb 15, 2017. With earnings of the utility companies that have reported so far were up 10.2% on 8.4% higher revenues.
The regulated nature of operation and domestic focus keeps the utilities insulated from foreign currency fluctuations, which is a serious concern for some other sectors. Additionally, utility services like electricity and water are yet to have any viable alternative. Consequently, this assures steady demand for the services rendered by the utility operators.
Utility operation is capital-intensive and the companies need to approach capital markets for funds. So, the rock bottom interest rates that prevailed in the U.S. for nearly a decade acted as a tailwind for this sector. Finally the interest rates were revised upwards in Dec 2015 and again the rates were raised in Dec 2016. Further, the Fed Reserve official also announced their intention to increase interest rates for three more times this year if economic conditions are favorable, which does not augur well for utilities.
The upward revision in interest rates hurts utilities, as it increases their financing cost and impacts their ability to pay regular dividends. This could make bonds a more attractive investment option than utilities in a rising interest rate environment.
New Hope for Utilities under President Trump
Former U.S. President Obama’s introduction of Clean Power Plan had made the utilities operate in a different manner. Utilities started to lower usage of coal in electricity generation, and focused more on natural gas and renewable source to produce electricity.
However, Trump’s Presidency is expected to benefit defensive and domestic-oriented utilities immensely, though conventional wisdom runs counter to this view in light of underperformance of high-dividend stocks in rising interest rate backdrop.
During Trump’s election campaign, he had vowed to lower the regulatory pressure on domestic manufacturers and suggested increased investment in energy infrastructure. If the new administration indeed starts working on these lines, the entire utility sector is bound to get a boost.
Factors that can drive Demand for Utilities
The U.S. economy is also showing consistent signs of improvement with the unemployment rate declining to 4.7% in Dec 2016 from 5.0% in Dec 2015, per the data released by Bureau of Labor Statistics.
The Federal Reserve Board expects manufacturing capacity in the U.S. to advance 1.1% in 2017, somewhat faster than the 0.7 % registered 2016. Further, the capacity in the mining sector is estimated to rise 0.9% in 2017, after witnessing a fall of 3.4% in 2016. No doubt these positive developments will further increase the demand for utility services.
Q4 earnings in the Utility sector are expected to improve 5.6% driven by 15.5% growth in revenues.
Selecting the Right Ones
Picking the right stocks to add to your portfolio could seem quite daunting given the huge number of companies operating in the utility space. One way to narrow the list down is to look at stocks that have a solid Zacks Rank and a positive Earnings ESP. The combination of a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) and a positive Earnings ESP is usually a meaningful indicator of an earnings beat. You can uncover the best stocks to buy or sell before they’re reported with ourEarnings ESP Filter.
Earnings ESP is our proprietary methodology for determining which stocks have the best chance to pull a surprise in their next earnings announcement. It shows the percentage difference between the Most Accurate Estimate and the Zacks Consensus Estimate.
Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.
All the following stocks provide regular dividend to shareholders, which is a trademark of the utilities.
Applying the above strategy, we have selected five utility stocks that have a greater possibility of posting an earnings beat this season.
The Southern Company (SO - Free Report)
Southern Company serves nearly nine million customers through its eleven electric and natural gas distribution units across nine states. The company’s operations include wholesale electricity generation and natural gas services, retail energy services and natural gas storage operations throughout the country.
Southern Company carries a Zacks Rank #3 and has an Earnings ESP of +6.45%. You can see the complete list of today’s Zacks #1 Rank stocks here.
The company has a long-term earnings growth expectation of 4.12% and a forward P/E of 16.18. The company has delivered an average positive earnings surprise of 7.71% in the trailing four quarters. The current dividend yield is 4.64%.
The company is expected to report fourth-quarter 2016 results on Feb 22.
Aqua America Inc. (WTR - Free Report)
Aqua America Inc. is a water and wastewater service provider. The company through its regulated utilities provides water or wastewater services to nearly three million people in Pennsylvania, Ohio, Texas, Illinois, North Carolina, New Jersey, Indiana and Virginia.
Aqua America carries a Zacks Rank #3 and has an Earnings ESP of +3.45%.
The company has a long-term earnings growth expectation of 5.50% and a forward P/E of 21.88. The company has delivered an average positive earnings surprise of 1.31% in the trailing four quarters. The current dividend yield is 2.54%.
The company is expected to report fourth-quarter 2016 results on Feb 22.
FirstEnergy Corp. (FE - Free Report)
FirstEnergy Corporation is a diversified energy company which operates through its subsidiaries and affiliates. The company engages in the generation, transmission and distribution of electricity, as well as energy management and other energy-related services.
FirstEnergy has a Zacks Rank #3 and an Earnings ESP of +2.56%.
The company has forward P/E of 11.30. The company has delivered an average positive earnings surprise of 7.34% in the trailing four quarters. The current dividend yield is 4.70%.
The company is expected to report fourth-quarter 2016 results on Feb 21.
ONEOK Inc. (OKE - Free Report)
ONEOK Inc., an energy company, is engaged in natural gas and natural gas liquids (NGL) businesses. ONEOK is primarily focused on rendering management support and resources to ONEOK Partners and creating value for its shareholders through its ownership in the partnership.
ONEOK Inc. has a Zacks Rank #3 and has an Earnings ESP of +4.26%. The company has a long-term earnings growth expectation of 5.00%. The current dividend yield is 4.55%.
The company is expected to report fourth-quarter 2016 results on Feb 27.
PNM Resources, Inc. (PNM - Free Report)
PNM Resources through its subsidiaries is involved in the energy and energy-related businesses in the U.S. The company is primarily involved in the generation, transmission, and distribution of electricity.
PNM Resources has a Zacks Rank #3 and has an Earnings ESP of +12.90%.
The company has a long-term earnings growth expectation of 6.53% and a forward P/E of 19.31. The company has delivered an average positive earnings surprise of 6.51% in the trailing four quarters. The current dividend yield is 2.76%.
The company is expected to report fourth-quarter 2016 results on Feb 28.
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