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All Contents © 2020The Kiplinger Washington Editors
By Will Ashworth, Contributing Writer
| January 8, 2020
When investors think defense, they think utility stocks.
The S&P 500's utility sector behaved anything but defensively in 2019, however. The Utilities Select Sector SPDR Fund (XLU) delivered a 25.9% total return last year – better than more than half the index's sectors, including the revamped, "growthier" communications sector and consumer discretionary stocks.
That's surely a pleasant surprise for utility-stock investors. Many enter the sector looking not for growth, but stability in down markets and the dependable dividends these companies can afford thanks to the often regulated nature of the utility business.
Like most of the market, utility stocks did get stretched as a result of their 2019 run. "The utility sector currently trades at a P/E of 19.3x, versus a 15-year historical average of 15.01x, which represents a 29% premium to the S&P 500," Michael Sheldon, executive director and CIO of financial planner RDM Financial Group, told Kiplinger in a December email.
While Sheldon is concerned about the sector's valuation, he's also quick to point out that many utility stocks have low beta – a measure of volatility. Thus, they're still providing more stability compared to the overall market.
Here are 10 of the best utility stocks to buy for 2020. This isn't your usual group of utilities, either. While some of these names should be expected to provide a traditional combination of dividend income and lower volatility, a few are set up for potential growth thanks to their connection to green-energy initiatives.
Data as of Jan. 7. Stocks listed alphabetically. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price. Analyst opinions compiled by The Wall Street Journal.
Market value: $7.5 billion
Dividend yield: 4.0%
Analysts' opinion: 7 Strong Buy, 0 Overweight, 3 Hold, 0 Underweight, 0 Sell
Toronto-based Algonquin Power & Utilities (AQN, $14.18) held its 2019 Investor Day in early December. And the company had plenty of good news to discuss across meetings in both Toronto and New York.
As the utility stock heads into its next decade of growth, management was keen to discuss its plans for "greening" its regulated business, its pursuit of renewable-energy projects and the simplification of its overall business. To that end, Algonquin plans to spend $9.2 billion over the next five years. Roughly $2.5 billion of its capital expenditures will be directed toward renewable energy. That arm of AQN's business currently has 3 gigawatts in generating capacity – 79% from wind, and the rest coming from solar, hydro and thermal.
Algonquin also is finding mergers-and-acquisitions (M&A) opportunities that can help it grow on a sustainable basis. In 2019, it closed on acquisitions of St. Lawrence Gas and New Brunswick Gas, both purchased from Enbridge (ENB). Since 2009, AQN has acquired 25 regulated utilities as part of its long-term growth plan.
Algonquin has been one of the best utility stocks over the past few years when considering price and dividends. AQN pointed out in its investor-day presentation that, through Sept. 30, its 10-year annual shareholder return has averaged 23.7% – more than three times the S&P/TSX Composite Index (of Canadian stocks) and double the PHLX Utility Sector Index.
Raymond James analyst David Quezada came away from Algonquin's presentation impressed, calling the company "our top power and utility sector pick" in a note to clients. "This planned capex supports expected EPS growth of 9-11 per cent which we believe places AQN well above most North American utility peers," he adds.
Market value: $21.7 billion
Dividend yield: 1.7%
Analysts' opinion: 5 Strong Buy, 1 Buy, 5 Hold, 1 Sell, 1 Strong Sell
The history of American Water Works (AWK, $120.00) dates all the way back to 1886, when it was founded as the American Water Works and Guarantee Company. It became the American Water Works in 1947. The modern-day stock is much newer, however – it went public on April 23, 2008, when it was spun off from Germany's RWE Group.
American Water Works owns regulated and market-based water utilities in 46 states and one Canadian province, providing services to more than 14 million people. Of its 2018 revenue of $3.4 billion, 87% was from its regulated business; the remainder came from its market-based business, which includes things such as water services for military installations, warranty services and water-related services to the oil-and-gas industry.
Through 2023, American Water Works expects to grow its earnings by 7% to 10% annually, with 5 to 7 percentage points of that growth from its capital spending plan for its regulated businesses. It will spend approximately $1.7 billion annually over the next four years.
It's also expanding its customer base in multiple ways. Through the end of October, AWK had closed on acquisitions that had added 46,900 new customers in 2019, and had other acquisitions in process that will add 26,400 more. It also had added 10,400 customers organically through October 2019.
American Water Works has a few other accolades worth mentioning. In 2019, Barron's named the company one of the 100 Most Sustainable Companies – its second consecutive year making the list. AWK plans to reduce its greenhouse gas emissions by 40% by 2025. Through infrastructure spending, it has reduced its annual water usage by 3.5 million gallons. The utility also was named to the 2019 Bloomberg Gender-Equality Index, an acknowledgment of its commitment to transparency in gender reporting and advancing women's equality.
If you're driven to dividends, AWK has grown its payout by 10.3% compounded annually.
Market value: $10.0 billion
Dividend yield: 2.0%
Analysts' opinion: 4 Strong Buy, 1 Buy, 3 Hold, 0 Sell, 0 Strong Sell
Water-related utility stocks such as AWK and Aqua America (WTR, $46.32) are benefiting from the growth in ESG (environmental, social and corporate-governance) investing, which pushed up the stock prices of U.S. water utilities in 2019.
"A lot of those ESG funds use water utilities as a proxy of water scarcity," Angie Storozynski, managing director and senior analyst at Macquarie Capital, told CNBC in October. "They have been doing particularly well because there is this additional environmental oversight."
Since 2015, the number of ESG funds holding water-utility stocks have more than doubled to 86, through the end of June 2019.
In October 2018, Aqua America announced it would pay $4.3 billion for Pennsylvania's natural gas utility Peoples Gas. The deal was done to turn Aqua America into an energy infrastructure company, diversifying its revenue streams beyond water.
Originally, the acquisition was expected to close in mid-2019. Unfortunately, it has hit a few regulatory snags along the way. However, at the end of October, a judge for the Pennsylvania Public Utility Commission ruled that the purchase is in the best interests of Pennsylvania residents. The full PPUC should rule on it early this year, with Aqua America expecting to close the deal soon thereafter.
The combined entity would have a rate base of $7.2 billion (69% water, 31% natural gas) with customers in 11 states, including Aqua America's home state of Pennsylvania. Together, it would serve more than 1.7 million customers and have an enterprise value of $13.4 billion.
Analysts expect WTR to report 5% to 6% profit growth for both full-year 2019 and 2020. Meanwhile, Aqua America increased its dividend by 7% at the beginning of September, and has improved it by 7.3% annually over the past half-decade.
Market value: $8.4 billion
Dividend yield: 4.4%
Analysts' opinion: 2 Strong Buy, 0 Buy, 10 Hold, 0 Sell, 0 Strong Sell
Canadian renewable-energy stocks rewarded investors quite handsomely in 2019.
Among the best performers was Brookfield Renewable Partners LP (BEP, $47.11) – the 60%-owned renewable-energy affiliate of Brookfield Asset Management (BAM), one of the world's biggest alternative asset managers. Including dividends, Brookfield Renewable delivered a total return of 88.0% in 2019 – significantly higher than most utility stocks, and almost triple the S&P 500.
BEP looks positioned to be one of the best utility stocks not just for 2020, but the decade.
Renewable-energy stocks have become understandably popular with the ESG crowd. "The cost of renewables has come down substantially over the past five to 10 years, to the point where they are competitive even without subsidies," Chris Namovicz, the U.S. Energy Information Administration's renewable electricity analysis team leader said in a recent interview.
To make Brookfield Renewable's stock even more popular with investors, it is making a new structure that will allow for a broader investor base, including exchange-traded funds (ETFs).
"We are creating a structure that will allow our investors' additional optionality to invest in Brookfield Renewable through either the current partnership or through a newly created publicly listed Canadian corporation known as BEPC," CEO Sachin Shah stated during the company's Q3 2019 conference call. "Both … will provide investors access to the same globally diversified renewable power portfolio with a strong track record of growth."
In other words, whether you hold the partnership units or shares of the Canadian corporation, you will continue to benefit from the same quarterly distributions as in the past, along with above-average capital appreciation.
Market value: $26.8 billion
Dividend yield: 2.6%
Analysts' opinion: 8 Strong Buy, 0 Buy, 6 Hold, 1 Sell, 2 Strong Sell
New England-based Eversource Energy (ES, $82.68) made Kiplinger's 2019 list of the top utility stocks to buy. It didn't disappoint, delivering a total return of 34.1% in 2019. And it should continue to please shareholders in 2020.
At the end of last year, ES made a splash by announcing it intends to be carbon neutral by 2030 – 20 years ahead of targets set by peers Duke Energy (DUK) and Xcel Energy (XEL).
Why does this matter?
As investors become more green, Eversource will be able to attract a lower cost of capital, which will help it maintain its Standard & Poor's A-rated balance sheet while continuing to grow its earnings by 5% to 7% annually over the next five years. Evidence suggests that greener utilities can save 1% or more off the coupon rate of a conventional bond compared to utilities more exposed to fossil fuels.
If Eversource achieves carbon neutrality by 2030, it would be the first investor-owned utility in the U.S. to do so. It's clearly on its way: In 2018, Eversource divested all its remaining fossil generation facilities.
It's no wonder that Eversource is in the top 100 of Just Capital's 2020 rankings of America's Most Just Companies. More importantly, it is the top utility out of 36 ranked by Just Capital.
Eversource expects to spend $9.8 billion on its core businesses through 2023. Included in this spending are three offshore wind projects that, when operational (they should all be up and running by 2024), will generate more than 1,700 megawatts of electricity. Meanwhile, analysts' expectations for profits for full-year 2019 and 2020 both meet the company's internal goal of 5% to 7% annual earnings per share growth.
Market value: $19.3 billion
Dividend yield: 3.5%
Analysts' opinion: 6 Strong Buy, 0 Buy, 9 Hold, 0 Sell, 1 Strong Sell
Newfoundland, Canada-based Fortis (FTS, $41.60), which serves nine states and five Canadian provinces, also made Kiplinger's 2019 list of best utility stocks to buy. And FTS's performance last year also impressed, with a 28.6% total return that bested the sector by 3 percentage points.
If dividend income is important to you, Fortis is as solid as they come. It's one of the longest-tenured Canadian Dividend Aristocrats, boasting uninterrupted annual payout hikes for 46 years. Given that, and its nice 3.5% yield, FTS is among utility stocks you'll want to own for decades to come.
"If (Fortis) can grow that dividend every year, even by 5 per cent a year for the next 10 years, the dividend will be 1.65 times what it is today," Ryan Bushell, portfolio manager at Toronto-based Newhaven Asset Management, told The Globe and Mail in December. "That, for me, is a forever stock. It's focused on changes in the electricity grid and renewables. This is a company that has its head up and is going to continue to be sustainable."
To continue to grow, Fortis will spend $14 billion over the next five years – a $770 million increase over its previous five-year plan. With 99% of the capital expenditures going toward its regulated businesses, investors should be confident that the healthy dividend will continue to grow.
In December, Fortis raised $844 million in share offerings, selling $460 million worth to a group of Canadian banks and $384 million worth to a U.S. institutional investor.
"Capital investments such as these benefit utilities because they increase the 'rate base' on which they can earn a regulated return," Globe and Mail columnist John Heinzl writes. "So the money Fortis raised will help the company increase its earnings."
Market value: $117.9 billion
Dividend yield: 2.1%
Analysts' opinion: 15 Strong Buy, 0 Buy, 1 Hold, 1 Sell, 0 Strong Sell
NextEra Energy (NEE, $241.31) was another of last year's top utility stocks to buy, and it came through with flying colors, reaping a total return of more than 42% in 2019.
It looks like an excellent bet yet again in the year to come.
Like Brookfield Renewable, NextEra has made a significant push into renewable energy. NextEra has a 57% economic interest in NextEra Energy Partners LP, the company's investment vehicle for renewable power. However, unlike BEP, NextEra has a diversified business model that includes a large regulated-utility business.
NextEra has committed to investing $14 billion in its overall business over the next three years, with half of that going toward renewable energy. If you like renewable energy but are afraid to invest in a pure play such as Brookfield, NextEra makes complete sense.
At the end of September, NextEra Energy Partners' portfolio of assets included 5.3 gigawatts of renewable energy – 86% wind, 14% solar. It also included 727 miles of natural gas pipelines capable of carrying 4.3 billion cubic feet of natural gas each day, 81% of which is already contracted out in long-term deals. The overall NextEra Energy Partners business expects to deliver an after-tax annual total return of 16% to 19% for the next five years through 2024.
By investing in NextEra Energy, you also get Florida Power & Light – the largest regulated utility in the U.S. with more than 5 million customers. That makes NEE a lot more attractive should a recession rear its ugly head in 2020.
Market value: $9.3 billion
Dividend yield: 0.3%
Analysts' opinion: 8 Strong Buy, 0 Buy, 2 Hold, 0 Underweight, 0 Sell
NRG Energy (NRG, $36.87) was one of the bigger stragglers in the utility sector last year, moving virtually sideways in a year the XLU climbed almost 26%.
It has a lot of catching up to do, but not to fear.
NRG operates two businesses: retail and wholesale power generation. On the retail side, it distributes electricity and natural gas to more than 3 million customers in 19 states, the District of Columbia, and two Canadian provinces. It is the largest retail provider of electricity in Texas.
Analysts generally like NRG stock, as indicated by eight Buy-equivalent ratings versus just two Holds. In September, Morgan Stanley upgraded it to Overweight (Buy) from Equal Weight (Sell), and raised its 12-month target price by $2 to $49 per share, suggesting 33% upside from current prices. MS adjusted it twice more since then – up to $55 per share, then down to $54 in mid-December, that that's still a nearly 50% gain expected within the next year.
NRG Energy hasn't offered investors much in the way of dividends in the past, but that's about to change. In October, the utility announced it would raise its quarterly payout from 3 cents per share to 30 cents during the first quarter of 2020. That would take its yield at current prices from 0.3% to 3.3%. And the company plans to grow that dividend by 7% to 9% annually going forward.
NRG is committing 50% of its free cash flow to dividends and share repurchases, with the other half going to growth investments.
Market value: $377.4 million
Dividend yield: 2.5%*
Expenses: 0.40%, or $40 annually on a $10,000 investment
The beauty of equal-weight ETFs such as the Invesco S&P 500 Equal Weight Utilities ETF (RYU, $104.79) is that they don't play favorites.
RYU tracks an index of 28 equally weighted utility stocks: 50% electric utilities, 36% diversified utilities, and the remainder a combination of gas and water utilities, independent power producers and energy traders.
Over the past decade, the index, which is rebalanced quarterly, has suffered only one year of negative returns. That was in 2015, when it lost 4.0%. Its average annual gain of 12.1% over the past decade is 1 percentage point shy of the S&P 500 – that's saying something considering that it's one of the most defensive sectors versus a much more growthy index across 10 years' worth of bull market.
Of RYU's current holdings, four are featured in this article – NextEra, NRG Energy, Eversource and American Water Works. The average market cap is about $32 billion, which is solidly large-cap territory, Indeed, more than two-thirds of the fund is made of large-cap stocks, with mid-caps accounting for the rest.
* Trailing 12-month yield, which is a standard measure for equity funds.
Market value: $10.7 billion
Dividend yield: 3.0%
The biggest difference between the Utilities Select Sector SPDR Fund (XLU, $63.91) and the Invesco S&P 500 Equal Weight Utilities ETF is that the latter is equal-weighed, the former is market-cap-weighted – in other words, the bigger the stock, the more assets it accounts for within the ETF.
XLU's holdings are identical to the RYU's 28 holdings – all S&P 500 utility stocks. The only difference is that XLU's top 10 holdings account for roughly 61% of the fund's $10 billion-plus in assets, while RYU's top 10 holdings account for just 38%.
So, if you like NextEra, which is the ETF's top holding at a weighting of more than 13%, XLU provides a nice alternative to owning NEE because it reduces company-specific risk while still giving you a decent-sized slug of NextEra exposure.
RYU has outperformed XLU over the trailing 10-year period, though SPDR's fund has led the way over all the significant shorter-term time frames. Given that XLU charges annual expenses of just 0.13% versus 0.40% for the equal-weighted ETF, costs are a decent part of that advantage. It's also helped by that outsize exposure in NextEra, which has been one of the best utility stocks of the past few years.
Traders also tend to like XLU over RYU because it's more liquid (in other words, more shares trade hands each day, making it easier to buy or sell at exactly the price you want).