OK. Utility stocks are boring. But boring is what you want at this point in the business cycle.
Runaway inflation is squeezing the bottom line as many companies struggle to pass along higher input costs to consumers. Meanwhile, revenue is under pressure because Fed rate hikes are decelerating economic activity. Furthermore, a big run-up in the Dollar means converting foreign currency sales back into U.S. Dollars has created another headwind. In short, this isn't the friendliest of business environments!
The drumbeat over a recession is strengthening, and it's not only here in the United States, where GDP fell 1.6% in Q1, and may fall again in Q2. Inflation and geopolitical instability are a global problem. For example, this week, the European Commission reduced its GDP growth outlook for the European Union to 2.6% from 2.7% in May. It was 4% in February. It also reduced its estimate for 2023 to 1.4% from 2.3% in May.
Given that backdrop, tucking "boring," yet steady-eddy stocks like utilities into portfolios makes sense. Utility rates are regulated, so there's price clarity. And electricity demand is largely inelastic to economic craziness. Moreover, utilities' predictable profits mean most pay shareholder-friendly dividends, further insulating against risk.
If that sound good, then it could be time to add a few utility stocks to portfolios.
In "These 3 Utility Stocks Offer High Yields, Recession-Proof Dividends," Real Money Pro's Bob Ciura makes a case fore case for buying Consolidated Edison (ED) , Southern Company (SO) , and Duke Energy (DUK) , three of the biggest U.S. utility companies.
ConEd provides electricity in New York, New Jersey, and Pennsylvania. It also has a renewable energy business with 3 gigawatts of projects, including solar farms in Texas and California, which it may divest. According to Bloomberg, that sale could fetch up to $4 billion for shareholders.
Last quarter, the company's top and bottom line results were solid. Ciura writes,
"Consolidated Edison in early May revealed first-quarter results, showing revenue grew 10.3% to $4.1 billion, beating estimates by $350 million. Adjusted earnings of $522 million, or $1.47 per share, compared to adjusted earnings of $491 million, or $1.44 per share, in the previous year."
Management expects full-year earnings per share between $4.40 to $4.60 this year, up from $4.39 last year. In 2020, EPS was $4.18 (not bad given the negative impact to economic activity from COVID). According to Ciura, EPS increased at a 1.4% average annual rate over the past decade. That's not barn-burning growth, but it's a nice steady increase that's supported its dividend.
Currently, ConEd pays an annualized dividend of $3.16 per share, but that's likely to increase. According to Ciura, "The company has increased its dividend for over 40 consecutive years, placing it on the exclusive Dividend Aristocrats list. With a 2022 payout ratio expected in the 70% range, ConEd's dividend is safe."
Management plans to invest $68 billion over the coming 10 years with $1.2 billion slated for clean energy through 2024, including $300 million to create 21,000 electric plug installations for EVs by 2025.
The performance of the company's shares in the past during a recession is also encouraging. Ciura writes, "In the Great Recession, when most companies saw their earnings collapse, earnings for Consolidated Edison fell just 3% in 2008 and 7% in 2009, and it took only one year to return to the pre-crisis level."
Southern Company is an electric utility operating, unsurprisingly, in the South! Its network includes Florida, Alabama, Georgia, and Mississippi. Overall, it boasts about nine million customers.
Although earnings per share declined slightly year over year, it reported solid revenue growth during the first quarter.
"Revenue grew 12.5% over last year's quarter, thanks to rate hikes and strong customer growth. But these benefits were offset by high operational and maintenance costs and thus EPS slipped by 1%, from $0.98 to $0.97.
Southern has missed analysts' EPS estimates only once in the last 21 quarters and reaffirmed its guidance for adjusted EPS of $3.50-$3.60 in 2022."
Despite the slight dip in EPS in Q1, Southern Company still outpaced analysts' estimates by $0.06. At the midpoint of its '22 guidance, EPS will increase 4% this year. Next year, analysts are modeling for earnings to increase by 7% to $3.80.
Similar to ConEd, those earnings should continue supporting its dividend, which has increased in 21 consecutive years, including an $0.08 bump up to $2.72 per share in April. Moreover, it has a history of keeping its payout steady in tough periods. Its dividend has been equal or greater than the prior year every year since 1948.
Currently, it yields a healthy 3.8%. However, there's a chance that increases once it finishes construction on its new nuclear plant in Georgia (the first new plant in the U.S. in 30 years). During its Q1 earnings call management said, "We believe once Vogtle 3 and 4 are completed, our Board will have the opportunity to consider accelerating the rate of dividend growth."
Duke Energy provides energy to 7.4 million customers across various states, including the Carolinas, Florida, Ohio, Kentucky, and Indiana. It generates about 35% of its electricity from nuclear power plants, but it's also expanding into solar and wind.
Recently, it opened the first of 10 "community" solar sites in Florida. The site, which includes 265,000 solar panels on 500 acres, is expected to power 23,000 homes. In May, it won a lease from the U.S. to help develop wind power on Federal waters off the Carolinas.
Ciura notes the company produces "$26 billion in annual revenue and trades with a market capitalization of $83.8 billion," making it one of the biggest utilities you can buy. Its revenue grew 16% year-over-year to $7.1 billion in Q1, which helped its earnings increase to $1.30 from $1.26 last year.
Again, management's outlook for the full year is encouraging amid uncertainty. Ciura notes:
"Duke Energy reaffirmed its 2022 adjusted EPS guidance of $5.30 to $5.60 and long-term adjusted earnings per share growth rate of 5% to 7% through 2026.
Duke's earnings-per-share have increased at an annual rate of 4% over the last decade, and we expect to see Duke continuing to generate 4.8% annualized earnings-per-share growth over the next half decade as we expect management to deliver earnings-per-share above guidance for 2022.
On July 13, management increased its quarterly dividend payout by 2% to $1.005 per share, so shares are yielding 3.8%.
The Smart Play
Utilities are low-beta stocks, so they're significantly less volatile than the market itself. As a result, they should fall by less when the market tumbles. For example, Duke Energy's beta is only 0.24, so it's 76% less volatile than the market. Lowering the beta of your portfolio is one of many ways to minimize drawdown during bear markets. You can view a stock's beta easily online. For example, beta can be found on the statistics tab on Yahoo! Finance's stock pages.
If you buy these stocks and you don't need the income, consider reinvesting the dividends quarterly so that you own more shares over time.
If you don't want to own individual utility stocks, the SPDR Utilities Select ETF (XLU ) is an alternative. It owns 29 utilities, and its top five holdings are NextEra Energy (NEE) , Duke Energy, Southern Company, Dominion Energy (D) , and American Electric Power (AEP) . Therefore, if you buy it, you'll still get healthy exposure to two of the three names Ciura recommends. This year, the ETF's performance is about flat, so it's significantly outperforming the S&P 500. Additionally, its 0.10% expense ratio is low, and since it yields 2.9%, you'll still pocket a nice dividend payment.