After underperforming the past 12 months, utilities are one of the market’s least owned sectors. And despite solid Q4 earnings and guidance, many best in class companies sell for their most discounted valuations and highest yields in years, asserts Roger Conrad, editor of Conrad's Utility Investor.
The combination of strong businesses and low prices should provide solid support for best in class utilities and essential services stocks, even if the overall market does weaken. What we must be on the lookout for is any sign companies are weakening.
Since 1999, utility stocks have finished higher 7 years when interest rates have risen and never lower. In fact, three worst performances by far were during years of falling rates: 2008, 2002 and 2001.
That hasn’t prevented reflexive selling of utilities in the face of the 70 percent increase in benchmark 10-year Treasury yields. The silver lining is we have another great opportunity to buy the best in class like WEC Energy (WEC), a conservative holding in our model portfolio.
WEC serves 4.5 million electricity and natural gas distribution customers in Wisconsin (70 percent revenue), Illinois (15 percent), Michigan and Minnesota. It owns 60 percent of the American Transmission Company (ATC), operating the upper Midwest US power transmission grid.
Recently, its contract renewable energy business bought 90 percent of a 190-megawatt Kansas wind project, which will supply Facebook when it enters service in Q4.
WEC expects regulated decarbonization efforts to drive 7 percent annual rate base growth through 2025 in business friendly Wisconsin.
CAPEX plans feature $1.8 billion in infrastructure upgrades and 1.8 gigawatts of new renewable energy capacity, including the state’s first solar (200 MW) and battery storage (100 MW) project scheduled for service in early 2023.
WEC plans to reduce overall CO2 emissions 70 percent by 2030, with $1 billion in savings for customers. That’s an efficiency formula management has consistently executed, cutting operating and maintenance costs by 3 percent in 2020 while targeting an additional 2 to 3 percent cut reduction for 2021. And utilities will also get a boost from solid and consistent 1 percent yearly customer growth.
WEC’s ability to routinely hit exceptionally narrow earnings guidance continues to merit a premium valuation for shares. Last year’s $3.79 per share, for example, actually beat the high end of the company’s initial pre-pandemic guidance range.
Risks to 2021 projections of $3.99 to $4.03 per share include the lingering pandemic, potential inability to execute cost reductions and potential regulatory setbacks.
Fortunately, none are likely this year. And the only real surprises so far have favorable, namely federal extension of wind and solar tax credits to speed utility decarbonization. Trading more than 5 percent below my highest recommended entry point of 90, WEC is a great buy for even the most conservative investors.