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All Contents © 2019The Kiplinger Washington Editors
By Ellen Chang, Contributing Writer
| August 30, 2019
Utility stocks and funds are in a fortuitous position right now. Investors tend to seek them out when recession fears creep (like they are right now), and they also tend to perform well when interest rates decline.
Several countries have shown signs of economic weakness, sparking worries about a global recession. The U.S.-Chinese trade war hasn’t helped, blunting the growth of the planet’s two largest economies. And Derek Horstmeyer, an assistant finance professor at George Mason University, points out what many experts have said about the yield curve’s recent inversion. Namely, he calls it a “strong signal that we are in the late stages of economic expansion and may indeed be headed for a recession within the next 18 months.”
That’s a boon to safe-haven sectors such as utilities and consumer staples, as what they produce is always in demand, no matter what the economy is doing. Utility stocks, with their high returns on assets and high dividends, should be considered given that they “tend to do well in late-cycle periods,” Horstmeyer says.
The utility sector also is attractive as interest rates fall, says Robert Johnson, a finance professor at Creighton University. “The dividend yield on the utility sector is especially attractive in this abnormally low-interest-rate environment as the yields on utility stocks exceed the yields on long-term U.S. government debt by a substantial margin,” he says.
Here are 11 utility stocks and fund to buy for safety and income. This list includes a few standouts in the sector, as well as several ways to diversify your risk while collecting these stocks’ above-average dividends.
Data is as of Aug. 29. Dividend yields are calculated by annualizing the most recent quarterly payout and dividing by the share price. Analysts’ opinions provided by The Wall Street Journal.
Market value: $13.9 billion
Dividend yield: 4.2%
Analysts’ opinion: 11 Buy, 0 Overweight, 6 Hold, 0 Underweight, 0 Sell
Houston-based CenterPoint Energy (CNP, $27.62) has more than 7 million customers in eight states and owns electric transmission and distribution, power generation and natural gas distribution businesses.
Utilities, which have outperformed Standard & Poor’s 500-stock index so far in 2019, are just off their peak valuation relative to the index. However, Michael Underhill – chief investment officer at Capital Innovations in Pewaukee, Wisconsin – isn’t worried. “On an interest-rate-adjusted basis, the utility group is near levels last seen in early October,” he says. “At the current valuation, we (think utility stocks are) at least well-supported at current rates.”
He also isn’t sweating CNP’s recent underperformance (it’s off 3% year-to-date versus a nearly 18% gain for the sector). He says CenterPoint is being over-penalized considering the company’s robust utility growth profile.
Underhill – who has a $32 price target on CNP, implying potential upside of 16% from current levels – says the company should register 6.9% annual earnings per share (EPS) growth between 2018 and 2021.
Market value: $105.9 billion
Dividend yield: 2.3%
Analysts’ opinion: 15 Buy, 0 Overweight, 2 Hold, 1 Underweight, 0 Sell
Florida-based NextEra Energy (NEE, $221.12), the world’s largest utility stock by market value, serves about 5.5 million customers across two Floridian subsidiaries. It’s also one of the most exciting utility stocks on the market.
Chris Osmond, chief investment officer at Prime Capital Investment, says NextEra is turning heads via its green energy initiatives. NextEra, through subsidiary NextEra Energy Resources and other affiliates, is the world’s top renewable-energy generator.
Capital Innovations’ Underhill adds that some investors are worried about the impact of tax credits expiring in the early 2020s on renewable energy growth. But he emphasizes that renewable technologies continue to drop in cost at a rapid rate.
“We have owned and will own a significant position in NEE for the foreseeable future,” says Underhill, who has a price target of $234 (6% upside).
This environmental, social and governance (ESG) pick is more than just a happy story. It’s an outperformer. Over the past 10 years, NEE has delivered 440% in total returns (price plus dividends), versus 246% for the S&P 500. Moreover, it has been increasing its dividends annually every year for more than two decades.
“NextEra stands out due to its earnings growth and free cash flow,” Osmond says – good news for the utility stock’s ability to continue boosting that payout.
Market value: $44.8 billion
Dividend yield: 3.0%
Analysts’ opinion: 9 Buy, 0 Overweight, 8 Hold, 1 Underweight, 0 Sell
American Electric Power (AEP, $90.72) is an Ohio-based company serving 5.4 million customers in 11 states. It owns or operates 60 generating stations, with a combined capacity of 26,000 megawatts that can power 26 million customers.
In 2018, the company reported a 5% year-over-year improvement in revenues to $16.2 billion in revenue, and a 7% bump in operating profits to $3.95 per share. Those don’t sound like screaming numbers, but remember: Regulated utilities aren’t expected to churn out breakneck growth. They tend to swell slowly over time instead.
Underhill says the company’s key risks include cost of management, regulation, power demand and financing. He has a conservative $92-per-share price target on the stock right now, in part because AEP has already run 24% higher this year.
“We still remain bullish on AEP,” he says, “albeit slightly less bullish given its recent outperformance versus the sector index.”
Market value: $33.3 billion
Dividend yield: 2.5%
Analysts’ opinion: 4 Buy, 0 Overweight, 9 Hold, 0 Underweight, 1 Sell
Xcel Energy (XEL, $64.60) is a utility holding company based in Minnesota whose stock has been hitting all-time highs on a seemingly daily basis over the past few weeks.
Xcel Energy has met or exceeded earnings guidance for 14 consecutive years. That includes ongoing EPS of $2.47 in 2018, which was a healthy 7% better than its year-ago profits. Better still, the company increased its long-term EPS growth target during the third quarter of last year, projecting 5% to 7% annual increases going forward.
Xcel also improved its payout by 6.6% in February, to 40.5 cents per share – in line with its target annual dividend increase range of 5% to 7%. The company has raised its every year since 2003.
In an Aug. 1 research report, Morningstar strategist Travis Miller writes that two regulatory developments in Colorado and Minnesota, the largest service territories, “could help hone Xcel’s long-term earnings growth outlook.” Xcel asked for a $158 million electric rate increase in Colorado starting in January 2020. Meanwhile, XEL plans to increase wind, solar and peaking generation in Minnesota while retiring two large coal plants there.
“Xcel’s long-term growth depends on regulatory support for this plan at least in concept,” Miller writes. “We think Xcel will receive that support.”
Market value: $67.6 billion
Dividend yield: 4.1%
Analysts’ opinion: 4 Buy, 0 Overweight, 12 Hold, 1 Underweight, 1 Sell
Charlotte-based Duke Energy (DUK, $92.76) is one of the largest utility stocks in the U.S., and highly decorated to boot. It has been named to Fortune’s 2019 list of the World’s Most Admired Companies and Forbes’ 2019 list of America’s Best Employers. It’s also one of 24 S&P 500 companies run by a female CEO – a case study for the benefits of gender diversity in corporate management.
Duke recently reported second-quarter operating earnings of $1.12 per share, up 20% year-over-year and better than analysts’ estimates. Its GAAP (generally accepted accounting principles) income has varied from year to year, but encouragingly, it has steadily grown its revenues by about 3% annually since 2015.
The company’s dividend of 94.5 cents per share – reflecting a 2% increase announced in July – comes out to a yield of 4.1%. That’s about 77% of Duke’s projected 2019 profits, which is just outside its targeted 65% to 75% earnings payout ratio range.
Duke also anticipates spending $37.5 billion through 2023 on growth projects. Its goal with these projects is to win government approval for a rate increase, which should lead to 4% to 6% earnings growth within that period, Prime Capital Investment Advisors’ Osmond says.
Duke Energy, like NextEra, places emphasis on ESG factors. Among other things, it has invested in renewable energy (such as wind, solar and biomass) since 2007.
Market value: $11.0 billion
Dividend yield: 3.1%*
Expenses: 0.13%, or $13 annually for every $10,000 invested
Electricity, gas and water are considered the most basic of needs, so they’re among the last things people cut even in the worst of economies. Thus, this sector tends to withstand turbulent market environments and can be a good defensive component in an investor’s portfolio, says Mike Loewengart, vice president of investment strategy at E*Trade.
Investors looking to group several utility stocks together to reduce risk have their choice of funds.
First up is the Utilities Select Sector SPDR Fund (XLU, $62.56), which is the market’s biggest utility-stock exchange-traded fund, at well more than twice the assets of its next-largest competitor.
The utility sector isn’t a very broad one, so most funds in the space tend to have relatively small portfolios. But XLU is exceptionally tight, holding just the 28 utility stocks within the S&P 500.
“The fund dominates its segment with vast assets and volume, but is also concentrated in a handful of large firms,” Osmond says. Indeed, NextEra Energy accounts for 12.5% of the ETF’s assets. Duke Energy is another 8%. The top 10 holdings alone are 40% of the fund’s weight. “Competing utility ETFs offer wider-ranging exposure to the full market-cap spectrum,” he says.
Still, XLU is a cheap, liquid, easy option that gives investors access to the industry’s biggest blue-chip names. And its 3.1% dividend yield is far better than the sub-2% payout on the S&P 500, and more than double the 1.5% yield on 10-year Treasury bonds.
* Yields represent the trailing 12-month yield, which is a standard measure for equity funds.
Market value: $4.1 billion
Dividend yield: 2.9%
The Vanguard Utilities ETF (VPU, $138.99) is a bit cheaper and offers a more diversified portfolio than XLU. This ETF holds roughly 70 companies in the business of distributing electricity, gas or water, or operate as independent power producers. Like XLU, it’s a simple index fund. In this case, VPU tracks the MSCI US IMI Utilities 25/50 Index – an index of large, midsize and small companies within the utility sector.
The good news? You have more holdings, so you’re spreading your risk around a bit more than XLU. But it’s still concentrated at the top, with NextEra Energy accounting for 10.5% of assets, and Duke another 6.7%. Dominion Energy (D) and Southern Co. (SO) command 6%-plus weights, too.
VPU, like XLU, offers a dividend well ahead of the market and Treasury bonds. It also should provide investors with a smoother ride than the broader market.
“The fund is also attractive from a risk standpoint as the beta of the fund is 0.31, much lower than the overall market beta of 1.0,” Creighton University’s Johnson says. “This indicates that on average this fund is much less volatile than the market, both on the downside and upside.”
Osmond also points out a potential risk to some utility funds: namely, if interest rates recover.
“In higher-interest-rate environments, the debt on leveraged investments become more expensive,” Osmond says. “And while the debt-to-equity ratios on some of XLU’s top holdings like DUK (1.38) and NEE (1.20) are not terrible, they’re not comforting in higher-interest-rate environments.” VPU would be in a similar boat.
Market value: $897.4 million
Dividend yield: 2.7%
“Given the current environment, the offerings of utilities provide the backdrop and potential to earn attractive income and potential for positive gain,” Osmond says. “Investors’ demand for exposure to utility stocks typically increases for two main reasons: investors are seeking a high level of income and/or investors are fearful of what the future holds and start defensively positioning their portfolio.”
Stuart Michelson, a finance professor at Stetson University, agrees, saying that utilities provide a good addition to a diversified portfolio. He also says iShares U.S. Utilities ETF (IDU, $157.50) is one example of an attractive utility investment.
IDU is yet another indexed utility ETF – one that splits the difference between XLU and VPU with a 48-stock portfolio of companies that provide electricity, gas and water, as well as a splash of independent power producers.
NextEra (11.2%) again rules the roost, at an 11.2% weight, followed by Duke Energy (7.1%) and Dominion (6.6%).
Market value: $243.0 million
Dividend yield: 1.7%
Now, something a little different.
The Invesco DWA Utilities Momentum ETF (PUI, $34.22) isn’t a straightforward index fund like XLU, VPU and IDU, which simply select a group of utilities and rank them by size. Instead, PUI tracks the Dorsey Wright Utilities Technical Leaders Index, which instead selects stocks based on their relative strength (or momentum) – essentially, how a security is performing versus some group of peers. This portfolio of 30 stocks is then weighted by the companies’ momentum scores.
The result? While you have many of the same names, companies such as Duke Energy and NextEra don’t hold nearly the same weight in PUI as they do in the other indices. For instance, while NextEra still is the second-largest holding in PUI, it’s only 4.2% of the fund. Top holding WEC Energy Group (WEC) is 4.4% of the fund – one to two percentage points higher than its weighting in XLU, VPU and IDU. And third-largest holding CMS Energy (CMS, 4.1%) doesn’t even make the top 10 of any of the other three index ETFs.
The nature of this strategy also means the fund delivers a much more balanced blend of different-sized utility stocks. Roughly 41% of the fund is invested in large-cap stocks, while almost half are in mid-caps and the rest in smalls.
It’s a different ETF, but the strategy has worked at times. PUI has outperformed XLU, VPU and IDU by total returns (price plus dividends) over the trailing one- and three-year periods.
* Includes a 23-basis-point fee waiver.
Market value: $1.2 billion
Dividend yield: 1.3%
Investors who prefer a seasoned hand to manage their utility stocks, rather than an index, can look to the Fidelity Select Utilities Portfolio (FSUTX, $93.09).
Douglas Simmons has managed the fund since 2006, and has helped steer it to a four-star Morningstar rating. It has been in the top half of all competing funds over the trailing five-, 10- and 15-year periods, and its 14.0% average annual return over the past three years makes it the top mutual fund in its Morningstar category.
This is a decidedly different portfolio than the index funds mentioned above. Yes, it’s tight, at 32 holdings, and it’s weighted more heavily in larger-cap names. But NextEra doesn’t dominate and Duke doesn’t even find itself within the top 10 holdings. Instead, Simmons currently favors Dominion, Exelon (EXC) and Sempra Energy (SRE) as his top three stocks.
The one downside to this actively managed portfolio? It’s more expensive to own than any of the aforementioned ETFs.
Market value: $6.5 billion
The Franklin Utilities Fund Class A (FKUQX, $21.85) is another strong actively managed utility-sector mutual fund – one that has been in the top half of its category across all meaningful time periods. It has heated up of late, too, boasting a one-year performance of 21.5% that’s second-best in its class.
FKUQX is a team effort: It’s managed by John Kohli, who has been with the fund since 1998, and Blair Schmicker, who joined in 2009. They invest more than half the fund (55.5%) in electric utilities, with multi-utilities (31.9%) and water utilities (4.7%) making up most of the rest of the fund.
Franklin does favor NextEra at the moment, allocating 8.3% of its assets to the utility stock. American Electric Power (5.1%) is high on the team’s list, too, as is Dominion (4.9%).
* The Class A version is relatively new. Franklin’s previous Class A version of the fund (FKUTX) was renamed A1 and closed to new investors in September 2018. The new Class A shares sport a different expense structure, which includes a maximum 3.75% sales charge on initial purchases.