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Utility Industry Stock Outlook - Jan.-Feb. 2017

The Utility sector is mature and fundamentally strong. Demand for utility services is barely impacted by economic ups and downs. It's because these companies provide basic services like electricity, gas and water, which can never go out of demand. This provides these companies with the ability to boost shareholders' value through consistent dividends and share buybacks, making them all the more attractive.

Stocks of utility companies enjoy a reputation for safety given the regulated nature of their business, which give their revenues a high level of certainty. They also benefit from the domestic orientation of their business, which shields them from foreign currency translation issues that have been a headwind for many other industries lately. The Dow Jones Utility Average (DJU) is up 6.8% year over year (as of Jan 30, 2017).

To provide an uninterrupted supply of basic amenities, utilities need to upgrade and strengthen their infrastructure and modernize the generation fleet. The water utilities in particular are positioned for massive growth as billions of dollars in regulated investment are required to upgrade soiled and old water infrastructure. These modifications enable utilities to meet increasing demand and abide by stringent environmental regulations laid out by state and federal agencies.

These capital intensive utilities therefore routinely take recourse to capital markets to meet the above requirements. Though regulated utilities are cash generators, the funds generated from internal sources are less than sufficient to carry out long-term projects. Given their business model, the Dec 2016 interest rate hike will increase the cost of capital and make operations costlier for utilities.

The Fed may yet again increase interest rates in 2017 if economic factors are conducive for such a move. If the cost of capital increases further for utilities, investors might turn to bonds as an alternative source of investment.

The New President & the Environmental Challenge

Historically, Electric utilities have heavily relied on coal for a large part of power generation, which has become a big challenge for the group in these times of enhanced environmental awareness. To curb pollution, utilities are installing smart meters, attaching scrubbers to lower emissions and launching energy efficiency programs to reduce customers' energy consumption.

To adhere to the Clean Power Plan, some utilities had taken steps to curb emission levels, which included shutting down old coal-based power plants, investing in emission control equipment, and increasing the share of natural gas and alternate energy sources in electricity generation.

There was, however, strong opposition to the enforcement of this Clean Power Plan, as a large group felt it was too harsh and will have an adverse impact on other industries like coal apart from utilities. The Supreme Court ruling in Feb 2016 temporarily stayed the implementation of this Clean Power Plan and blocked the efforts of the U.S. administration to lower global warming by regulating emissions from coal-fired power plants.

President Trump could introduce policies to benefit coal-based utilities. Even though we have yet to see any concrete plan, Trump's election campaign suggest future policies in favor of fossil fuel-based utilities.

Speculations of various changes such as shuttering the Environmental Protection Agency (EPA), discontinuing the Clean Power Plan and policies aimed at reviving the coal industry are rife. If such plans are indeed implemented, fossil fuels will undoubtedly get a major boost.

Positive Factors to Boost Demand

Per the U.S. Bureau of Labor Statistics, the unemployment rate in Dec 2016 was 4.7%, lower than the year-ago level of 5.0%. The drop in unemployment indicates improving economic strength, which in turn will drive demand for utility services.

An Energy Information Administration (EIA) report forecast net retail electricity sales to increase gradually a compounded rate of 0.8% over the 2016-2050 time frame. Over the long term, renewable energy and natural gas will become major fuels for electricity generation.

Zacks Industry Rank - Positive

Within the Zacks Industry classification, utilities are a standalone 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.

We rank all of the 257 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 .

In the complete list of Zacks Industry Ranks for the 257+ industries, the outlook for industries with a Zacks Industry Rank of #88 and lower is 'Positive,' those between #89 and #176 is 'Neutral' and those with #177 and higher is 'Negative.'

Note that three industries related to the utility sector - Gas Distribution, Electric Power and Water Supply - each falls under the first category, with a Zacks Industry Rank of #42, #86 and #88, respectively.

Our present outlook for the utility sector is Positive, with all the three major industries in this space currently holding a favorable rank. Electric Power and Water Supply have moved to the Positive territory since our last update.

Earnings Trends

Here's how these safe investment bets fared in the third quarter of 2016 and how they're placed ahead of their fourth-quarter earnings release. Third-quarter earnings in the utility space increased 16.3%, compared with a 3.8% improvement for the S&P 500 index.

Earnings for the fourth quarter are expected to improve at a clip of 3.0%, compared with an improvement of 5.2% for the S&P 500. Revenues at the sector are expected to improve 15.2% in the fourth quarter, higher than expected growth of 4.0% for the S&P 500. For more information on earnings for this sector and others, please read our 'Earnings Preview ' report.

Utilities Worth Buying

Investors may keep an eye on the following utilities, all of which have the financial strength to withstand a gradual increase in interest rates without compromising on dividend payments.

MDU Resources Group, Inc. (MDU) has a long-term earnings growth projection of 8.17%. The utility surpassed estimates in three out of the trailing four quarters with an average beat of 12.00%. The stock has a current ratio of 1.54 and a dividend yield of 2.63%. Its 2016 earnings estimates moved up 1.8% in the last 60 days. MDU Resources sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here

CenterPoint Energy Inc. (CNP) sports a Zacks Rank #1 and a long-term earnings growth projection of 5.00%. The utility exceeded estimates in three out of the last four quarters with an average beat of 5.07%. The stock has a current ratio of 1.05 and a dividend yield of 3.95%. Its 2016 earnings estimates moved up 2.6% in the last 90 days.

ONE Gas, Inc. (OGS) has a long-term earnings growth projection of 5.93%. The utility surpassed estimates in the last four quarters with an average beat of 12.46%. The stock has a current ratio of 1.46 and a dividend yield of 2.17%. Its 2016 earnings estimates moved up a penny in the last 90 days. ONE Gas currently carries a Zacks Rank #2 (Buy).

Vectren Corporation (VVC), another Zacks Rank #2 stock, has a long-term earnings growth projection of 5.33%. It surpassed estimates in two out of the last four quarters, with an average beat of 2.31%. The stock has a current ratio of 1.00 and a dividend yield of 3.09%. Its 2016 earnings estimates moved up 0.8% in the last 90 days.

The Best Place to Start Your Stock Search

To help you find the most promising stocks in this industry, you are invited to download the full list of 220 Zacks Rank #1 "Strong Buy" stocks - absolutely free of charge. Since 1988, Zacks Rank #1 stocks have nearly tripled the market, with average gains of +26% per year. Plus, you can access the list of portfolio-killing Zacks Rank #5 "Strong Sells" and other private research. See these stocks free >>

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Vectren Corporation (VVC): Free Stock Analysis Report

ONE Gas, Inc. (OGS): Free Stock Analysis Report

MDU Resources Group, Inc. (MDU): Free Stock Analysis Report

CenterPoint Energy, Inc. (CNP): Free Stock Analysis Report

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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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