Utilities: Across The Universe
Summary I currently favor utilities in the current market environment. While the sector has trailed in 2015 in anticipation of rising interest rates, this may be present investors with opportunity today. Investors may be well served to focus on specific themes within this space. With this in mind, it is worthwhile to take a walk across the utilities universe. I currently favor utilities in the current market environment. Following a strong advance in 2014, the sector has been under pressure for much of the year due in large part to concerns about the U.S. Federal Reserve and plans to raise interest rates. This recent weakness may be presenting investors with opportunity as they position for the future. But instead of taking a blanketed approach in allocating to the sector, investors may be well served to focus on specific themes within this space. With this in mind, it is worthwhile to take a walk across the utilities universe. Why Utilities? Utilities have struggled in 2015 in anticipation of the Fed raising interest rates. Given the interest rate sensitivity of the sector, this is not necessarily surprising. But many reasons exist to expect that utilities may be set to perform well once the Fed finally ends the suspense and starts hiking rates. First, utilities have demonstrated the ability to perform well during past rate hike cycles. During the period from June 2004 to June 2006 when the Fed last completed a interest rate normalization cycle by increasing the funds rate from 1.00% to 5.25%, the utilities sector managed to increase by a cumulative +52% in value. Not too shabby for a sector that investors are supposedly inclined to abandon when interest rates are rising. (click to enlarge) Of course, this assumes that the Fed will actually be able to complete a rate normalization cycle this time around, which is doubtful at best. This is due to the fact that unlike June 2004 or the numerous past interest rate hiking cycles that came before it, the Fed is seeking to accomplish the unprecedented by sustainably raising interest rates off of the zero bound, but also do so in a global and domestic economic environment that is languid at best and increasingly deteriorating in many parts of the world. As I’ve mentioned in past articles, the Fed is seeking to raise interest rates not because of the economy but despite the economy. As a result, it should be anticipated that the Fed may squeeze out one or two rate hikes at most in the coming months before they are forced to either stop or reverse course. And given that utilities offer stock investors both relative safety from a price stability perspective as well as high income from a total returns standpoint, such an outcome would likely prove beneficial to the utilities sector. And this may be particularly true given the fact that the sector has been sold off throughout much of 2015 in anticipation of an event in the Fed normalizing interest rates that may never come to pass. Exploring The Utilities Universe Suppose you are an investor that has interest in the utilities sector. One of the challenge that many immediately face when exploring utilities is that they like financials are not like most other sectors in the equity marketplace. In the case of utilities, they are mostly domestically focused (which may be an added plus for the sector given increasing currency volatility and expectations for a stronger dollar with operations that are located in a specific region of the country with pricing that in many cases is regulated by local government officials. Moreover, some of the metrics that investors focus on in evaluating utilities are unique to the sector. And among the individual names in the space are wide differentiations in terms of exactly how they are generating their power, getting along with their regulators and running their businesses. With all of this in mind, it is worthwhile to establish a snapshot framework for viewing and organizing the utilities industry. For the purpose of this report, I will be focusing exclusively on utilities that are domiciled in the United States and trade on one of the three exchanges in the NYSE, the NASDAQ and the AMEX. In total, there are exactly 100 U.S. firms that are designated as utilities that are exchange traded. But not all of these firms fit the specific criteria of the types of utilities that we would expect to perform generally in line with what we have defined for the broader utilities universe above. For example, some are master limited partnerships concentrated more on pipeline operations than distributing electricity to customers. Others are electricity wholesalers, which is a notably different business model than the traditional utilities business. With these items among others in mind, it is worth filtering down the utilities universe to its representative components. Included in this process is screening out companies that are set to be acquired as well as those that are trading at small market capitalizations and low average trading volumes that have the potential to present challenges from a liquidity standpoint. Lastly, only those utilities that pay investors a dividend are included, as this income is an important aspect in supporting the price stability of the utilities sector, particularly during periods of market instability. After conducting this screening process, we are left with 53 core public exchange traded utilities domiciled in the United States. These can be broken down into three main categories, which are shown below. Electric Utilities – 37 Gas Utilities – 7 Water Utilities – 9 The characteristics of the latter two categories are fairly straightforward, but electric utilities warrant further discussion. Electric Utilities First, let’s introduce the 37 names in the group including their market capitalization and current dividend yield. NextEra Energy (NYSE: NEE ) $46.4 billion 3.1% Duke Energy (NYSE: DUK ) $46.3 billion 4.9% Dominion Resources (NYSE: D ) $40.4 billion 3.8% Southern Company (NYSE: SO ) $39.9 billion 4.9% American Electric Power (NYSE: AEP ) $27.2 billion 3.8% Exelon (NYSE: EXC ) $26.3 billion 4.3% PG&E (NYSE: PCG ) $25.9 billion 3.5% PPL Corporation (NYSE: PPL ) $22.4 billion 4.5% Public Service Enterprise (NYSE: PEG ) $19.7 billion 4.0% Edison International (NYSE: EIX ) $19.6 billion 2.8% Consolidated Edison (NYSE: ED ) $18.3 billion 4.2% Xcel Energy (NYSE: XEL ) $17.9 billion 3.6% Eversource Energy (NYSE: ES ) $15.9 billion 3.3% WEC Energy (NYSE: WEC ) $15.6 billion 3.4% DTE Energy (NYSE: DTE ) $14.4 billion 3.7% FirstEnergy (NYSE: FE ) $12.8 billion 4.8% Entergy (NYSE: ETR ) $11.7 billion 5.1% Ameren (NYSE: AEE ) $10.6 billion 3.8% CMS Energy (NYSE: CMS ) $9.7 billion 3.3% SCANA (NYSE: SCG ) $8.5 billion 3.7% Pinnacle West (NYSE: PNW ) $6.9 billion 3.8% Alliant Energy (NYSE: LNT ) $6.6 billion 3.8% NiSource (NYSE: NI ) $6.1 billion 3.2% Westar Energy (NYSE: WR ) $5.8 billion 3.5% OGE Energy (NYSE: OGE ) $5.2 billion 4.2% Great Plains Energy (NYSE: GXP ) $4.1 billion 3.7% Vectren (NYSE: VVC ) $3.4 billion 3.7% IdaCorp (NYSE: IDA ) $3.3 billion 2.9% Portland General Electric (NYSE: POR ) $3.1 billion 3.4% Northwestern (NYSE: NWE ) $2.6 billion 3.6% ALLETE (NYSE: ALE ) $2.5 billion 4.0% PNM Resources (NYSE: PNM ) $2.2 billion 2.9% Avista (NYSE: AVA ) $2.1 billion 4.0% Black Hills (NYSE: BKH ) $2.0 billion 3.6% El Paso Electric (NYSE: EE ) $1.6 billion 3.0% MGE Energy (NASDAQ: MGEE ) $1.5 billion 2.8% Empire District Electric (NYSE: EDE ) $1.0 billion 4.7% An initial observation about the group listed above. It is worth noting that consolidation and acquisition activity has been taking place within the electric utility industry. This has included, Pepco Holdings (NYSE: POM ), TECO Energy (NYSE: TE ), Hawaiian Electric (NYSE: HE ) and Cleco (NYSE: CNL ), each of which has a market capitalization between $3 billion and $7 billion. Exactly how these utilities generate their electricity for their customers has a meaningful impact on their business operations and their stock prices. For example, electric utilities that emphasize using coal in the power production process are dealing with operational pressures resulting from increased carbon emissions standards from the U.S. Environmental Protection Agency. The nuclear generators have also been dealing with unfavorable market conditions and face event risk concerns that can spillover from high profile accidents like the Fukushima disaster in Japan back in 2011. As a result, it is worthwhile to consider exactly how these utilities generate their electricity. Coal The following is a subset of utilities that are most heavily reliant on coal in producing electricity including the percentage of their generating sources concentrated in coal. It should be noted that some publicly traded utilities do not disclose this information and may not be included in the list below as a result despite being reliant upon coal for power generation. NiSource 77% Ameren 74% DTE Energy 67% Great Plains Energy 64% PNM Resources 57% WEC Energy 56% ALLETE 56% SCANA 48% Westar Energy 48% MGE Energy 48% Alliant Energy 47% Empire District Electric 47% FirstEnergy 44% CMS Energy 44% OGE Energy 44% Southern Company 39% Duke Energy 37% Pinnacle West 34% IdaCorp 34% Black Hills 34% Dominion Resources 30% Of course, a small utility heavily reliant on coal for electricity generation may not be having the same environmental impact as a large utility that is more diversified in its power generation. As a result, it is also worthwhile to list those utilities mentioned above that are ranked highest in terms of carbon dioxide emissions according to a report by Ceres. According to the report, Duke, AEP, Southern Company, FirstEnergy and PPL all rank in the top ten in terms of total carbon dioxide emissions. Nuclear Applying the same criteria from above, the following are the subset of utilities that rely most on nuclear power in generating electricity for their customers. Exelon 67% El Paso Electric 47% Dominion Resources 33% Entergy 33% PNM Resources 30% Duke Energy 28% Pinnacle West 27% FirstEnergy 26% NextEra Energy 23% PG&E 21% Ameren 21% Hydro Two utilities standout in particular for their emphasis on hydroelectric power generation, while a few others register on the list. IdaCorp 35% Avista 32% PG&E 8% Portland General Electric 8% Exactly how each utility is generating their power is just one of the many factors to consider when evaluating an investment opportunity in the electric utilities space. Gas Utilities The natural gas distribution utilities universe consists of seven names. These are firms that are focused on the sale and distribution of natural gas and energy related products to its customers. In short, while a number of the utilities mentioned above have varying degrees of natural gas electricity production in their business, these are more purely natural gas electricity producers. Atmos Energy (NYSE: ATO ) $6.1 billion 2.6% WGL Holdings (NYSE: WGL ) $3.0 billion 3.1% New Jersey Resources (NYSE: NJR ) $2.6 billion 3.0% Laclede Gas (NYSE: LG ) $2.4 billion 3.3% South Jersey Industries (NYSE: SJI ) $1.7 billion 4.2% Northwest Natural Gas (NYSE: NWN ) $1.3 billion 4.0% Chesapeake Utilities (NYSE: CPK ) $0.8 billion 3.3% It should be noted that this group consisted of ten names at the start of the year, as AGL Resources (NYSE: GAS ), Piedmont Natural Gas (NYSE: PNY ) and UIL Holdings (NYSE: UIL ) are all in the process of being acquired in 2015. A primary driver of the acquisition binge in the natural gas distribution utilities space is the priority by many electric utilities, particularly those that are more reliant on coal, to diversify their generation sources with a shift toward natural gas. Water Utilities Distinctly different from their electricity producing relatives listed above but similar in the fact that they are also regulated at the local level, the following is the list of nine publicly traded water utilities. Within the broader utilities sector, these stocks have their own unique return and correlation characteristics that are differentiated from electric utilities as well as the broader market. American Water Works (NYSE: AWK ) $10.1 billion 2.4% Aqua America (NYSE: WTR ) $5.0 billion 2.5% American States Water (NYSE: AWR ) $1.5 billion 2.2% California Water Service (NYSE: CWT ) $1.0 billion 3.1% SJW Corporation (NYSE: SJW ) $586 million 2.7% Middlesex Water (NASDAQ: MSEX ) $397 million 3.1% Connecticut Water Service (NASDAQ: CTWS ) $391 million 3.1% York Water (NASDAQ: YORW ) $297 million 2.6% Artesian Resources (NASDAQ: ARTNA ) $223 million 3.6% Next Steps The opportunity set in the utilities universe is attractive and is likely to continue to be so for some time regardless of whether the Fed ends up raising rates or not. As a result, I will be placing an increased concentration on the utilities sector going forward on Seeking Alpha and will be drawing upon the framework introduced in this article for the purpose of future discussion and analysis. This will include a more in depth focus on individual names within the utilities space and timely recommendations on my premium service on Seeking Alpha. Disclosure : This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.