Utility services play a vital role in a nation's economic progress
as cheap and abundant supply of power keeps the wheels of
development rolling. With development comes the need for more
power, as cities expand, and the use of new gadgets increases.
However, everything comes at a price, as green-house gases emitted
by large utilities cause immense damage to the environment.
As per a U.S. Energy Information Administration (EIA) report, total
energy use in the U.S. will increase to 106.3 quadrillion Btu in
2040 from 95 quadrillion Btu in 2012. Most of this demand is
expected to come from the Industrial sector followed by the
Commercial sector. While demand for energy from the Industrial
sector is expected to increase 25.5% over the aforesaid period, the
Commercial sector is improving at a clip of 18.6% year over year.
Even so, the utilities have been under review for a long time. The
climate action plan of the U.S. President followed by the U.S.
Environmental Protection Agency's (EPA) proposal for tightening the
rules to set up new power plants are putting immense pressure on
power producing units.
Utilities are now gradually shifting their emphasis towards natural
gas and alternate energy sources to produce power. Global concerns
about the pitfalls of green-house gas emissions supported by
increasingly stringent government regulations have brought
alternative energy into the limelight.
In such a scenario, progressive steps from the U.S. alone will not
be enough to counter the negative impact of global greenhouse gas
emissions. The variance in the socio-economic structure of
different countries and the quest for cheaper sources of
electricity are making the task difficult, if not impossible. In
fact, emission from power generators in the developing nations is
undermining the positive steps taken in the U.S. and Europe to curb
Within the Zacks Industry classification, Utilities are a
stand-alone sector, one of 16 Zacks sectors. The rural wire-line
telephone companies are also grouped within the Zacks Utility
sector, but the three major industries within this sector include
Electric Power, Gas Distribution and Water Supply.
The Utility sector's defensive attributes reflect the group's lack
of correlation with the broader market/economy. Of course, the
sector's reputation as a dividend payer also adds to its perceived
We rank all of the more than 260 industries in the 16 Zacks sectors
based on the earnings outlook for the constituent companies in each
industry. This ranking is available in the Zacks Industry Rank.
The way to look at the complete list of Zacks Industry Rank for the
260+ industries is that the outlook for industries with Zacks
Industry Rank of #88 and lower is 'Positive,' between #89 and #176
is 'Neutral' and #177 and higher is 'Negative.'
Scanning the industries in the Utility sector, three prominent
industries under this sector are currently ranked in three
different categories. Water Supply has a Zacks Industry Rank #40,
Gas Distribution has a Zacks Industry Rank #92 while Electric Power
is at Zacks Industry Rank #161.
The utilities on the whole recorded growth of 4.7% year over year
in the third quarter of 2013 as compared to 5.0% registered by the
S&P 500. Utilities hardly surpass expectations by a large
margin, primarily due to the regulated nature of their operation.
For 2014 and 2015, earnings from this sector are expected to
increase at rates of 6.5% and 4.8% year over year, lower than the
9.1% and 11.2% growth expected from the S&P 500 in these two
Annual net margins of the utilities are expected to increase from
8.9% in 2013 to 9.3% and 9.6% in 2014 and 2015 respectively.
However, margins at the S&P 500 are expected to expand at a
brisker pace of 9.6% in 2013, 10.4% in 2014 and 11.1% in 2015.
S&P 500 net margins will be primarily driven by the Technology,
Finance and Business Services sectors. The defensive nature of the
Utility sector is well reflected in its margin expansion forecast.
Of the 16 sectors, margin improvement projection for the Utility is
ranked at 8th over the 2013-2015 time frame.
For more information about earnings for this sector and others,
please read our 'Earnings Trends' report.
The emergence of Microgrids for power generation could threaten the
dominance of the age-old power distribution system in the U.S.
Microgrids have evolved from simple power backup systems to small
smart grids. The swift and cost effective installation of Micro
grids could help distribute electricity among the masses. These
rooftop solar systems meet the energy needs of the customers. In
addition, the customers are allowed to sell excess power back to
A report from American Society of Civil Engineers estimated that
utilities need to spend $763 billion by 2040 to properly modernize
and harden the existing grids against natural disasters. We believe
that rather than going for a very costly maintenance, it will be
economical to develop these Microgrids, which could lend support to
the existing system.
The EIA reported that electricity consumption in the U.S. will
increase from 3,826 billion kilowatt hours in 2012 to 4,954 billion
kilowatt hours in 2040, implying an average annual rise of 0.9%.
For the fuel type in energy generation, renewables and natural gas
will play an increasing role while coal and nuclear power will
gradually fall out of favor.
The new proposal from the EPA directs a new coal-based power plant
to limit carbon emission to 1,100 pounds of CO2 per megawatt-hour.
In addition, coal based power generators would have to meet a
somewhat tighter limit if they opt for an average emission over
multiple years. Going forward, we expect regulations to get more
and more stringent for power generation from coal fired units.
In this context, we believe fresh investments in the power sector
would go more to the development of natural gas based combined
cycle power plants. An EIA report indicates that natural gas will
become the largest fuel source for power production in the U.S. by
2040 thereby displacing coal.
EIA report indicates coal-fired power generation to drop from 310
gigawatts (GW) in 2012 to 262 GW in 2040. The decline is a function
of greater dependence on natural gas, usage of alternate energy
sources and stricter regulations. The utility operators
are implementing new technologies for the generation and
distribution of power. The introduction of smart meters will
benefit customers while the smart-grid technology is likely to
The electric utilities which would play an important role in
meeting this increased demand for power are
American Electric Power Inc.
Duke Energy Corp.
Pinnacle West Capital Corporation
NextEra Energy Inc.
) among others.
The utilities are in the process of releasing their fourth quarter
earnings results. Among the current releases, American Electric
Power and PPL Corporation surpassed earnings expectation by 7.1%
and 17.6% respectively, while
Dominion Resources Inc.
) missed expectation by a respective 5.7% and 9.1%.
Among the 76 electric utilities in our coverage, 2 stocks sports a
Zacks Rank#1 (Strong Buy), 11 stocks have a Zacks Rank #2 (Buy), 48
stocks hold a Zacks Rank #3 (Hold) and the remaining 15 stocks have
either a Zacks Rank #4 (Sell) or a Zacks Rank #5 (Strong
Natural Gas Utilities
The country has huge volumes of natural gas reserves and the new
fracking technology has multiplied natural gas production from rock
and rock structures previously considered uncommercial. A
study from NaturalGas.org pointed out that the natural gas reserve
in the U.S. increased by 39% in? from 2006 levels, thanks to the
implementation of new exploration techniques.
The natural gas utilities are not only expected to benefit from the
steady increase in domestic demand but also from exports that are
expected to rise significantly. We noticed positive movements in
the U.S. Industrial and Commercial sectors, which could drive
demand for natural gas.
Given the abundance of natural gas in the U.S. , after much
consideration, the U.S. Department of Energy (DOE) has granted
permission to export liquefied natural gas (LNG). To date, the DOE
has granted export licenses for LNG from four terminals, while
there are 21 pending applications awaiting approval. In Sep 2013,
electric and natural gas supplier Dominion Resources Inc. received
an approval from the DOE to export 770 million cubic feet of
natural gas a day (mmcf/d) for 20 years.
We believe the decision will allow U.S. nat gas producers to
channelize their production volumes (after meeting domestic demand)
to feed the ever increasing appetite for power in the global
LNG export could turn out to be a potential game changer for the
natural gas sector. Multi-fuel producer
CONSOL Energy Inc.
(CNX) has shifted its focus to concentrate more on natural gas and
has thus divested a few of its coal assets. After increasing
natural gas production, this company might also explore the
possibility of LNG export.
The EIA forecasts the use of natural gas in the U.S. to increase
from 25.6 trillion cubic feet (Tcf) in 20112 to 31.6 trillion cubic
feet in 2040.
The positive dynamics are going to benefit natural gas utilities
AGL Resources Inc.
Atmos Energy Corporation
National Fuel Gas Company
Southwest Gas Corporation
MDU Resources Group Inc.
), among others.
Over the long run the spot prices for natural gas are expected to
increase further from the present level of $4.80 per million
British thermal units (MMBtu) on Feb 7. The increasing demand from
the Industrial sector, for electric power generation and export
obligation could push prices to $7.65/MMBtu in 2040 as per EIA.
With more than 71 million domestic natural gas customers, the
natural gas market has enough room for the nearly 1,200 natural gas
utilities presently operating in the country.
We track 22 gas utilities, of which 4 stocks have a Zacks Rank #2
(Buy), 16 stocks hold a Zacks Rank #3 (Hold) while 2 stocks aren't
doing well at all with a Zacks Rank #4 (Sell).
The major challenge ahead for water utility operators is the aging
water and sewer infrastructure. Maintenance and development of
facilities play a crucial role and will test the financial
capabilities of the water utilities.
A report from Economic Development Research Group Inc. suggests an
alarming gap between the water infrastructural requirement and
actual investments planned for the coming years. The gap is
expected to reach $84 billion in 2020 and widen to $144 billion in
2040. The report also revealed that without proper renewal or
replacement, nearly 44% of the existing pipelines will become too
poor for operation by 2020.
The utility operators have begun to invest in their ageing
infrastructure, but it appears the initiatives are inadequate to
bridge the gap. The government should consider taking adequate
measures before things blow out of proportion.
A prominent water utility,
American Water Works Company, Inc.
) has lately resorted to the inorganic route to expand its
footprint. We view this as a smart move as larger companies will
likely have better provisions to address the infrastructure needs
of the industry.
Among the water utilities,
American States Water Company
Connecticut Water Service, Inc.
Consolidated Water Co. Ltd.
) registered positive earnings surprises in their latest reported
quarters. The water utilities are yet to release fourth quarter
earnings results. The recent performance of these water utilities
indicates that these will register sequential growth in the fourth
quarter of 2013 as well.
We presently cover 12 water utilities, of which 2 have a Zacks Rank
#1 (Strong Buy), 2 have a Zacks Rank #2 (Buy), 5 stocks carry a
Zacks Rank #3 (Hold) and 3 stocks have a Zacks Rank #4 (Sell).
What Keeps the Utilities Going?
The biggest positive for the utilities is that there is hardly any
viable substitute for utility services. This is the most
fundamental strength of the industry. Moreover, increasing demand
drives this industry forward.
Another inherent advantage of these utilities is their size and the
requirement of huge initial capital outlay. For this reason,
we generally do not find many new entrants in the market. Also,
stringent government regulations and the hard toil for new entrants
to establish a loyal consumer base put existing players in an
Finally, utilities have been known to pay dividends consistently,
thereby retaining investor confidence. This was evident during the
economic crisis of 2008-2009 when these operators continued to pay
out dividends without fail.
Despite the assured demand for services, the utilities have to
constantly meet the high expectations of its wide customer base,
adapt to a changing global economic scenario, and upgrade
technologies to meet stringent environmental norms. In fact, new
technology to produce power at a cheaper rate and emerging
alternative resources for the generation of green power are likely
to drive the industry going forward.
Recently, defense major
Lockheed Martin Corp.
) along with Victorian Wave Partners Ltd decided to use ocean wave
technology developed by
Ocean Power Technologies Inc.
) to develop the largest wave energy project. The move skyrocketed
the trading price of Ocean Power Technologies.
The majority of new electricity in the next two decades in the U.S.
will be generated from natural gas and renewable sources. Besides
the abundance of natural gas, as many as 30 U.S. states and the
District of Columbia have enforceable renewable portfolio standards
or other renewable generation policies. We expect this count to go
up, compelling producers to generate more green power to meet the
renewable standards fixed by the states.
Population increase and the prevailing economic conditions are two
important factors which impact the demand for utility services. The
revised projection from the U.S. Census Bureau, indicates that
population growth in the U.S. will be lower by 0.2 percentage
points from the previous projection in 2040. The downward revision
could result in lower demand for utility services than previously
Moreover, utility operations globally depend on weather patterns
that determine the extent of demand. Erratic weather patterns
thereby impact the profitability of these operators, so much so
that their operational goals remain unmet.
To sum up, LNG exports will increase the profitability of the U.S.
natural gas operators. At the same time a concerted effort will
have to be made to remove the funding requirement in the water
utility sector. Otherwise the aging water infrastructure will lead
to more wastage, leading to a hike in cost of operation and a
related increase in the price of water supplied.
As for the electric utilities, we would expect more investment in
natural gas and alternate energy projects, wrenching the initiative
from the pure-play coal based electricity companies.
AMER ELEC PWR (AEP): Free Stock Analysis Report
ATMOS ENERGY CP (ATO): Free Stock Analysis
AMER WATER WORK (AWK): Free Stock Analysis
AMER STATES WTR (AWR): Free Stock Analysis
CONSOL ENERGY (CNX): Free Stock Analysis Report
CONN WATER SVC (CTWS): Free Stock Analysis
CONSOLTD WATER (CWCO): Free Stock Analysis
DOMINION RES VA (D): Free Stock Analysis Report
DUKE ENERGY CP (DUK): Free Stock Analysis
EXELON CORP (EXC): Free Stock Analysis Report
AGL RESOURCES (GAS): Free Stock Analysis Report
LOCKHEED MARTIN (LMT): Free Stock Analysis
MDU RESOURCES (MDU): Free Stock Analysis Report
NEXTERA ENERGY (NEE): Free Stock Analysis
NATL FUEL GAS (NFG): Free Stock Analysis Report
PINNACLE WEST (PNW): Free Stock Analysis Report
PPL CORP (PPL): Free Stock Analysis Report
SOUTHERN CO (SO): Free Stock Analysis Report
SEMPRA ENERGY (SRE): Free Stock Analysis Report
QUESTAR (STR): Free Stock Analysis Report
SOUTHWEST GAS (SWX): Free Stock Analysis Report
To read this article on Zacks.com click here.