Utilities That "Keep the Lights On"

10/29/2020 5:00 am EST


James Kelleher

Director of Research & Senior Analyst: Technology, Argus Research Corporation

Our rating on the Utilities sector is "Over-Weight". In an ultra-low interest-rate environment, we believe that investors will favor the safe income and steady EPS of the companies that “keep the lights on", notes Jim Kelleher, CFA and director of research with Argus Research.

Utility stocks face headwinds from slow earnings growth, but have been performing well, partly due to lower interest rates. As the yields of relatively safer bonds decline, dividend-yielding utility stocks become more attractive.

We believe that residential demand for power could increase as more Americans work at home (and spend more leisure time at home) due to the coronavirus.

Commercial demand may begin to recover as employees return to work. Utilities should benefit from a hybrid model in which both homes and offices will require full utility services.

Given recent and potential future rate cuts by the Federal Reserve in response to the virus, we expect Utilities to receive more attention from investors in the hunt for yield.

Large-scale solar investments may provide rate-base growth for utilities going forward, as regulated utilities provide solar power at about half the cost of roof-top solar, according to the Edison Electric Institute. Utilities also note that solar projects are zero-emission, and are seeking reasonable allowed returns on their investments.

Dominion (D), Duke (DUK), NextEra (NEE), and Southern Company (SO) are increasingly looking toward rate-base, utility-scale solar. About 58% of installed solar capacity is at utilities, with nonresidential (25%) and residential (17%) making up the balance.

Overall, we think the primary attraction of utility shares is steady and moderately growing income. We also believe that most utilities in our coverage group have secure dividends and will be able to access the capital markets for external funding as balance sheets remain underleveraged. We see the most attractive utilities as those that are able to innovate while also lowering costs.

We like Southern’s dividend yield of 4.4% in the current low-interest-rate environment. The company has a well-run base of regulated utility assets and has recently divested assets to focus on core operations.

It now expects more consistent mid-single-digit EPS growth. Southern’s balance sheet is solid. The dividend payout ratio was 54% in 2019, well below the peer average of 67%.

On the valuation fundamentals, the shares trade at 16.5-times our 2020 EPS estimate, in the lower half of the five-year historical range of 13.6-23.0 and below the peer average of 18.3. The price/book multiple of 2.0 is also below the midpoint of the historical range and slightly below the peer average of 2.1.

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