Utility stocks have been behaving erratically lately. Ever since the market took off, the conventional wisdom said that utility stocks would be the victim of rising interest rates and higher inflation. As investors know, high-interest rates can make utility stocks less attractive. Stock prices of utility companies started to fall in November 2017 and a popular utility stock index fund, the Utilities Select SPDR Fund (XLU) is down 11% since November. In contrast, the S&P 500 Index has climbed 4% in that same time period.
However, it may be time to change the thinking. While interest rates are rising, and it appears that they will continue to do so, the Federal Reserve has given no indication that the pace of those increases will take place at anything other than their current measured pace. This is good news for utility stocks because it means that much of the interest rate increase is already priced into the stock.
The other concern for utility stocks, inflation, is telling a different story. Call it the Amazon effect, but the innovation and the increasing footprint of technology companies are helping to suppress inflationary pressures. If inflation remains relatively contained, it will keep interest rates in check. Both are positive signals for utility stocks.
So if it’s time to get back into utility stocks, what are the best stocks to buy right now? That’s the focus of this presentation. We’re giving you five of our top picks of utility stocks that you should consider for your portfolio.
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- NextEra Energy
- Duke Energy
- Dominion Energy Inc.
- American Electric Power
- American Water Works Company
#1 - NextEra Energy (NYSE:NEE)
NextEra Energy (NYSE: NEE) - Renewable energy is here to stay. So when you look at utility stocks, the companies that are generating revenue from renewable energy, as well as traditional utility services, are smart plays. That's the case with NextEra Energy. Based just by market cap, NextEra is the largest electric utility in the United States. One of the reasons for that is the company has two distinct business units. The first is a traditional utility, Florida Power & Light. The utility services south Florida, which continues to be one of the fastest growing population centers in the country. In fact, NextEra services a customer base that numbers over 5 million.
But what should also get investors excited is their subsidiary, NextEra Energy Resources that builds and operates solar energy and wind farms. As more states mandate more of their power come from renewable sources, NextEra stands to profit. In fact, NextEra Energy Resources accounts for nearly 50% of the company’s overall business.
Over the last ten years, NextEra has managed to increase earnings and dividends at a rate of approximately 8% per year. One analyst sees this trend continuing and is forecasting NextEra Energy to generate 6%-8% annual earnings growth over the next five years. The stock is up nearly 15% year-over-year and it’s P/E ratio of 13.83, is consistent with their position as a category leader. The dividend yield is currently around 2.58%, the lowest it’s been in five years. However, with an expectation of continued robust earnings, investors shouldn’t let a modest dividend scare them away.
About NextEra Energy
NextEra Energy, Inc, through its subsidiaries, generates, transmits, distributes, and sells electric power to retail and wholesale customers in North America. The company generates electricity through wind, solar, nuclear,natural gas, and other clean energy. It also develops, constructs, and operates long-term contracted assets that consists of clean energy solutions, such as renewable generation facilities, battery storage projects, and electric transmission facilities; sells energy commodities; and owns, develops, constructs, manages and operates electric generation facilities in wholesale energy markets.
Read More - Current Price
- $64.00
- Consensus Rating
- Moderate Buy
- Ratings Breakdown
- 10 Buy Ratings, 2 Hold Ratings, 1 Sell Ratings.
- Consensus Price Target
- $71.36 (11.5% Upside)
#2 - Duke Energy (NYSE:DUK)
Duke Energy (NYSE: DUK) - Duke Energy is an example of why location matters. DUK’s primary markets are Central Florida and the Carolinas, two states that have a supportive regulatory environment. Plus, both states are showing strong residential customer growth of around 1.5%, giving them a growing base for their services. In Florida in particular, the company services the fast-growing cities of Tampa and Orlando. The combination of a growing economy and a recent string of unusually warm weather are causing revenue and earnings to climb at a slow, stable pace. Provided there is no softening in the economy, analysts foresee their growth trend continuing.
But an attractive service area is only part of the story. Duke is making a huge investment in its electrical grid and natural gas infrastructure, to the tune of $42 billion. This is news to investors ears as an investment like this will help support its annual earnings growth, which is currently around 6%. As part of this capital spending plan, Duke will put some money into its small renewable energy business.
Like the utility index, Duke’s stock is down about 10% since November, but the stock is up over 10% since hitting its 52-week low in June. One of the most attractive features of owning stock in Duke is its 4.5% dividend yield which is among the highest of all its competitors. Historically a yield above 4% means DUK still has room to rise.
About Duke Energy
Duke Energy Corporation, together with its subsidiaries, operates as an energy company in the United States. It operates through two segments: Electric Utilities and Infrastructure (EU&I), and Gas Utilities and Infrastructure (GU&I). The EU&I segment generates, transmits, distributes, and sells electricity in the Carolinas, Florida, and the Midwest.
Read More - Current Price
- $95.93
- Consensus Rating
- Moderate Buy
- Ratings Breakdown
- 6 Buy Ratings, 5 Hold Ratings, 0 Sell Ratings.
- Consensus Price Target
- $101.17 (5.5% Upside)
#3 - Dominion Energy Inc. (NYSE:D)
Dominion Energy Inc. (NYSE: D) - Unlike our first two companies, Dominion faces a couple of challenges, but when you’re looking for a company that generates a high dividend yield, few utilities can match what Dominion Energy brings to the table. Dominion has a large service area in the eastern United States and is one of the most diversified utilities with separate operations for electric transmission, regulated and non-regulated power generation and natural gas delivery and transmission through its controlled limited partnership, Dominion Energy Midstream Partners LP.
Similar to other utility companies, Dominion is planning robust capital expenditures to the tune of $4.2 billion per year across all its business categories. By creating more generating capacity, the part of their power generation that is regulated should increase helping to fuel the company’s projections of 6-8% annualized earnings growth through 2020.
While investors may love the current 4.63% dividend yield, it comes at a price. The company was expecting to sell off the assets of their controlled partnership but has had to step back from this plan. This is making some analysts concerned about their growth which will have to come from increased debt or from the sale of equity. Another concern is their potential acquisition of SCANA Corporation. While growth through acquisition is not uncommon in this sector, it would leave Dominion with the responsibility for cleaning up SCANA's failed nuclear power plant construction projects.
Dominion is still calling for dividend growth of up to 10% per year through 2020. That may ease concerns about short-term earnings pressure.
About Dominion Energy
Dominion Energy, Inc produces and distributes energy in the United States. It operates through three operating segments: Dominion Energy Virginia, Dominion Energy South Carolina, and Contracted Energy. The Dominion Energy Virginia segment generates, transmits, and distributes regulated electricity to approximately 2.8 million residential, commercial, industrial, and governmental customers in Virginia and North Carolina.
Read More - Current Price
- $48.55
- Consensus Rating
- Hold
- Ratings Breakdown
- 2 Buy Ratings, 8 Hold Ratings, 0 Sell Ratings.
- Consensus Price Target
- $50.10 (3.2% Upside)
#4 - American Electric Power (NASDAQ:AEP)
American Electric Power (NYSE: AEP) - You've probably noticed a theme. When it comes to utility stocks, bigger is better. And few utility companies cast as large a footprint as American Electric Power (AEP). The company operates across eleven states and services five million customers.
Make no mistake about it; AEP generates most of their revenue comes from their core business of generating power. With 26 gigawatts of power generation assets and 40,000 miles of transmission lines, they are a huge utility. But the company is making strides to adapt to the changing industry. They are reducing their reliance on coal for its power capacity. It’s currently around 50% (down from 70% in 2005) and they are working down to a low of 33%. They are also working to increase their renewable power base and have made impressive strides. Since 2005, they have tripled their renewable base from a minuscule 4% to 13%. This is one of their largest opportunities for growth and that is reflected in the company's future plans which include plans for 5.3 gigawatts of wind turbines and 3.1 gigawatts of solar construction through 2030.
One of the ways AEP is facilitating this plan is by selling assets. This shifting portfolio is lending support to the company’s projections for annual earnings growth in the range of 5-7%. With a share price around $73, AEP has largely recovered from the broad utility sell-off in November. The current dividend yield is around 3.3%, the stock still is showing room for growth.
About American Electric Power
American Electric Power Company, Inc, an electric public utility holding company, engages in the generation, transmission, and distribution of electricity for sale to retail and wholesale customers in the United States. It operates through Vertically Integrated Utilities, Transmission and Distribution Utilities, AEP Transmission Holdco, and Generation & Marketing segments.
Read More - Current Price
- $82.56
- Consensus Rating
- Hold
- Ratings Breakdown
- 6 Buy Ratings, 3 Hold Ratings, 2 Sell Ratings.
- Consensus Price Target
- $86.08 (4.3% Upside)
#5 - American Water Works Company (NYSE:AWK)
American Water Works Company (NYSE: AWK) - Just like every community needs power, they also need water. American Water Works is one of the largest utilities in this area. They provide drinking water and wastewater services to 1,600 communities in the United States and parts of Canada, making them the largest and most diverse publicly traded water company. And they are looking to make a large investment to upgrade their infrastructure which should make regulators happy and drive their long-term earnings growth. Some analysts are projecting that growth to be around 7%.
Another area that is driving their growth is acquisition. The company only operates in 16 states so there is a large opportunity to expand. These strategic acquisitions are forecast to add as much as two percentage points to the company’s earnings growth.
Add it all together and you have a company that’s projected to have earnings growth of around 10%. Does that make up for a dividend that is currently around 2%? Maybe, then again maybe not. But with its dominant footprint in this highly fragmented category, AWK looks like a solid investment.
About American Water Works
American Water Works Company, Inc, through its subsidiaries, provides water and wastewater services in the United States. It offers water and wastewater services to approximately 1,700 communities in 14 states serving approximately 3.5 million active customers. The company serves residential customers; commercial customers, including food and beverage providers, commercial property developers and proprietors, and energy suppliers; fire service and private fire customers; industrial customers, such as large-scale manufacturers, mining, and production operations; public authorities comprising government buildings and other public sector facilities, such as schools and universities; and other utilities and community water and wastewater systems.
Read More - Current Price
- $117.33
- Consensus Rating
- Moderate Buy
- Ratings Breakdown
- 2 Buy Ratings, 1 Hold Ratings, 0 Sell Ratings.
- Consensus Price Target
- $141.80 (20.9% Upside)
There are many reasons for investors not to buy into the narrative that buying utility stocks will harm their portfolio:
To begin with, interest rates are increasing, but the growth is measured and investors’ fears may be overblown. That’s because inflation is showing to be largely toothless which means there’s no imminent pressure for the Federal Reserve to raise rates beyond the measured, telegraphed way in which they have been operating. And historically, if both interest rates and inflation were to increase, regulators will usually allow utility companies to charge higher rates particularly for companies that are in highly populous areas.
Second, utility stocks are coming off a sell-off and are undervalued. Given that U.S. Treasury yields are between 2.5%-3%, utility stocks should be trading at levels above the S&P 500. They are trading at a pretty sharp discount so there's room for utility stocks to grow.
Third, even if the economy were to take a downturn, utility stocks have always been a good defense against bear markets. Having utility stocks in your portfolio will provide an opportunity for growth in any economy.
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