14 Oct

Utility Stocks: How These Defensives Fared Last Week

WRITTEN BY Vineet Kulkarni

Top utility stocks trended lower and lost 1.3% last week. Broader markets were positive but cautious on trade talk optimism, gaining 0.7% last week. So far this year, the Utilities Select Sector SPDR ETF (XLU) has risen more than 20%, outperforming the S&P 500.

Throughout this year, utilities have remained in focus due to the broader market uncertainties. Trade war tensions, a global economic slowdown, and recession fears have been pushing investors toward defensives for the last several months.

Top utility stocks

Top utility stocks NextEra Energy (NEE) and Duke Energy (DUK) fell more than 1% last week, and Southern Company (SO) fell 0.8%. Georgia-based Southern Company stock has surged more than 40% this year.

These utilities are trading close to their respective all-time highs at the moment. NextEra Energy is up about 32% so far this year. The extraordinary run in these utilities so far could have their movement capped going ahead.

Utilities’ dividends look attractive

Investors turned to these defensives, mainly due to their stable dividend profiles. Utilities at large currently yield 3%, higher than the benchmark 10-year Treasury yield. Top utilities Southern Company and Dominion Energy (D) yield 4% and 4.5%, respectively.

Apart from their premium yields, top utility stocks offer fair dividend growth for the future as well. From the earnings and dividend growth perspective, these stocks continue to look attractive. These defensives increased dividends by around 4% per year in the last five years, and they aim to grow at similar levels for the next few years. To learn more, please read Finding the Top Dividend Stock among Utilities.

Concerning valuation

The big movement in utilities this year has made them quite expensive. Southern Company and NextEra Energy look to be trading at a substantial premium compared to historical averages. They are trading at 20x and 26x their estimated earnings, respectively. Dominion Energy stock appears to be trading at a relatively reasonable multiple of 19x. Its stock is up about 15% year-to-date, notably underperforming its peers.

Utilities at large are trading around 19x their forward earnings, much higher than the historical average. They are expected to grow 4%–5% per year for the foreseeable future, which is much lower than that of the broader markets. In our view, the valuation multiple close to that of the broader markets for such slow growth seems unwarranted.

Based on estimates, the top utilities’ bottom line metrics are expected to remain largely flattish in the third quarter compared to Q3 2018. However, subdued earnings growth might not deter investors much. In the second quarter, the top utilities grew their EPS by around 5% year-over-year.

The top utility stocks look reasonably well placed, considering their respective moving average levels. They are trading above key support levels, which indicates strength.

Analysts seem positive on top utility stocks

Currently, Wall Street analysts appear positive on top utility stocks. Guggenheim Securities increased NextEra Energy’s price target from $230.00 to $250.00 on October 9.

SunTrust Robinson increased Southern Company’s target price from $59.00 to $62.00 last week. Mizuho Securities also increased SO’s target price from $60.00 to $62.00.

Evercore ISI raised Dominion Energy’s target price from $73.00 to $75.00 on October 7. SunTrust Robinson Humphrey raised Duke Energy’s target price from $96.00 to $100.00.

Despite recent price target raises, top utility stocks seem to be offering subdued upside potential for the next year. However, broader market uncertainty could put these defensives in focus. Their stable earnings growth and dividend payments could fairly compensate investors.

The potential of lower interest rates could be a vital positive factor for utilities. Utility stocks and interest rates generally trade inversely to each other. For additional insight, please read Why Utilities Could Keep Smashing in the Fourth Quarter.

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