Buying A Utility Right Now is Crazy, So Here's One to Consider

On the surface, even considering buying stock in a utility right now is crazy. The whole volatility thing was, after all, a result of interest rates jumping in the bond market amid fears of future inflation, and that has put pressure on the sector.

As regular readers will be aware though, contrarian trading is kind of my thing, so it will come as no surprise that I have been sniffing around utilities, looking for bargains, or at least stocks that represent solid, risk-controlled trades at current levels, and I think I have found one in Spark Energy (SPKE), a small Houston-based utility and provider of natural gas to domestic and commercial customers.

The first thing that attracted my attention in the case of SPKE was the chart. As you can see, it is, in a conventional sense, not a pretty thing. However, for someone looking for a contrarian trade it offers one big advantage. The recent bounce hints at finding a bottom, but more importantly the low of 9.20 represents a good level off which to set a stop loss.

The more astute (and cynical) among you, will be looking at that chart and noticing that the downward path is not a straight line and that there have been multiple other bounces that could have been interpreted the same way and would have led to losses. That is true but when you expand the chart beyond a 1-year time-frame, it is clear that this time is different.

The chart above starts at the beginning of 2016 and as you can see, around $9 (or more accurately its equivalent as there have been a couple of stock splits since) has proven significant for SPKE in the past. The low in March of 2016 was at $8.85, and a bounce off these levels looks a lot less random in that context. The technical setup is therefore sound, but that doesn’t mean much without two things.

To be a viable trade rather than just an idea SPKE must have a fundamental and financial situation that makes recovery possible, and a potential short-term spark for that bounce.

From a fundamental perspective, Spark, like utilities in general, carries a lot of debt, but solid levered free cash flow of over $41 million indicates that the company has that covered. Year on Year quarterly revenue growth is currently 36.3%, which would be good for any company, but is spectacular for a utility. That is not just a statistical anomaly either. Spark is a young company in the early stages of growth, and revenue has increased at a consistent high rate since the stock’s 2014 IPO.

The short-term spark could easily come from earnings, due on March 1st. That may seem like a strange thing to say given that the company has missed expectation in each of the last three quarters, but in some ways that is exactly why this release should prove to be supportive. Expectations have been tempered somewhat by the misses, with EPS for Q4 currently expected to be $0.31. Q4 is looking like a strong one across the board, and Spark is placed to benefit as much as anyone.

There is therefore a decent chance that Spark will surprise to the upside in a couple of weeks, and if they do the reaction could easily be exaggerated, as 3.6 million shares of the 11.4 million share float are currently shorted. That sets up a major short squeeze if there is any kind of a beat in Q4 but with established positions of that size probably limits the downside if the numbers do disappoint.

All in all, as strange as it may seem to be buying a utility in a rising rate environment, Spark is worth consideration. It is not a typical utility in that it is a growth story, has good debt coverage and free cash flow, and is close enough to multi-year lows to make that level useful for setting a stop. It is, based on the last year’s performance, undoubtedly a risky trade, but maybe buying in here is not that crazy after all.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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