In this series, we’ve already discussed how the Fed’s most recent rate hike and projected rate hikes for 2017 could impact utilities going forward. Another important factor that is likely to move utilities is company earnings, which depend on weather patterns and forecasts, electricity prices, and expected electricity consumption.
Electricity consumption has turned flat after peaking in 2008, mainly due to energy efficiency programs. However, lower-than-normal temperatures are expected to boost electricity consumption in early 2017. The chart below shows the quarterly profit margins of the top three utilities in the S&P 500 Utilities (XLU) Index.
Changing dynamics of the utilities industry
US utilities’ earnings are forecast to grow by an average of 4%–6% in the next few years. The modest growth outlook of electricity consumption has led US utilities to expand beyond their traditional utility operations, and bigger utilities have taken the inorganic route by acquiring smaller utilities in order to grow in gas distribution and in their midstream segments.
Southern Company’s (SO) and Duke Energy’s (DUK) business mixes, for example, are now less dependent on their electric segments due to added exposure to gas distribution after recent acquisitions. NextEra Energy’s (NEE) presence is also expected to substantially grow in Texas from its Oncor acquisition.
Meanwhile, midsize utilities are trying to expand their midstream operations to achieve above-normal earnings growth. For this reason, we can expect increased capital spending in midstream operations and renewables.
In a nutshell, an improved rate base facilitates improved earnings prospects for utilities. Consequently, bigger utilities may see accelerated earnings growth after contributions from acquired entities begin.