By Al Root
As Donald Trump's chances of winning the U.S. presidential election powered up, utility stocks powered down. But income investors should stick with the sector.
Utilities are supposed to be a solid, sleepy group of stocks offering yield-hungry investors nice quarterly payouts and low volatility, more sensitive to the direction of interest rates than who might manage to win the White House in 2024. That wasn't the case on Monday, however, when the Vanguard Utilities exchange-traded fund dropped 2.3%, and big utilities such as AES and NextEra Energy fell 10% and 6.6%, respectively.
The reason for the drop is simple: A second Trump term could reduce or eliminate tax credits supporting the buildout of utility-scale wind power and solar projects, effectively making renewable power projects more expensive to build and finance.
How a utility produces power doesn't seem like it would make that much of a difference. Whatever the source, its job is to make electricity and sell it to its customers. But how much they charge can change depending on the source. Coal and natural gas operating costs are passed through to customers, but regulated utilities are allowed to earn returns on capital investments.
As a result, a utility does a little better when it generates power from a renewable source than using coal or natural gas. Trump's proposed 10% tariff on all U.S. imports also would raise costs for utilities looking to buy wind and solar equipment.
Now, the expected path for earnings growth might be lower for utilities, but only buy a little, says Virtus CEO and portfolio manager Jay Rhame. He's bullish on several utilities because of a shift that is bigger than the mix of U.S. power-generating assets: Electricity's demand growth is as strong as it has been in generations. For evidence, Rhame points to Amazon.com's March deal to buy essentially all the power from Talen Energy's nuclear power plant in Pennsylvania at rates Rhame suspects are above current prices. "We're going to have to build as much power [generation] as we can," he says.
Three of his preferred stocks are Talen, Constellation Energy, and Vistra. Talen and Constellation are priced like growth stocks, trading for about 38 times and 26 times estimated 2024 earnings, respectively. Talen doesn't pay a dividend yet, while Constellation yields just 0.7%. Vistra trades for about 17 times estimated 2024 earnings and yields about 1.1%. The three stocks are up an average of 91% this year to date.
If that jump scares some income investors, who might also be put off by those paltry yields, there are always the utilities ETFs. The Vanguard Utilities ETF yields about 3.7% and trades for about 17 times estimated 2024 earnings. Earnings growth for the stocks in the ETF is expected to average about 7% for the next few years.
Average earnings growth in the iShares U.S. Utilities ETF matches the Vanguard ETF. Shares trade for an average of about 17.3 times and yield an average of 3.6%. The Virtus Reaves Utilities ETF looks a little more growth-oriented. It yields about 3.1% and stocks in the ETF are expected to grow earnings at an average rate of almost 7.5% over the coming few years. The average price/earnings ratio in the fund is about 17.3 times.
All three look like solid options for yield-oriented investors. Recent nervousness can be a chance to buy the dip in a sector with a solid outlook, no matter what happens in November.
Write to Al Root at allen.root@dowjones.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
July 18, 2024 04:00 ET (08:00 GMT)
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