Understanding Utilities in the Long Term despite Minor Price Targets

Did You Miss the 2016 Utility Rally—Or Is More to Come?

(Continued from Prior Part)

Challenges for the utility sector

Energy efficiency programs have been pressing utilities’ top lines over the past half decade. The weather has also severely impacted the sales of utilities in the past couple of quarters, and as a result, the electric business has witnessed negligible growth.

Utilities are thus going beyond their traditional operating approach and seeking growth in the non-utility segments like midstream and storage. Apart from that, utilities like Duke Energy, Southern Company (SO), and Dominion Resources (D) are expanding their natural gas (UNG) distribution operations through mergers and acquisitions.

Utilities are also increasingly investing in renewables, because distributed generation (on-site generation) remains another point of concern for them. The implementation of the US Clean Power Plan is also expected to be a capital-consuming regulation for utilities with heavy coal (KOL) in their fuel mixes. These utilities include Duke Energy (DUK), DTE Energy (DTE), and American Electric Power (AEP).

Utilities attractive for the long term?

Although utilities do not have attractive price targets for the next one year, they still seem to be poised for long-term growth. Utilities’ increasing investments in their rate bases as well as their expansion activities in Midstream and renewable (PBW) are expected to drive earnings growth in the future. Factors like weather and interest rates are expected to play in favor of utilities this year, given the record heat in the US, which may support their bullish movement. The volatility and growing uncertainty among equities (SPY) could also keep inflows coming in utilities.

That said, company valuations will remain the focal point of uneasiness in utilities (XLU) in 2016. Such a premium valuation is an alarming signal—and yet another reason why Jeffery Gundlach of Doubleline Capital suggests selling utilities now.

Browse this series on Market Realist:

• Part 1 - Have Utilities Lost Their Allure after the Unusual Rally in 2016?

• Part 2 - How Utilities Outwitted Other Sectors in 2016

• Part 3 - Inside Utilities’ Performance after an Unimpressive 1Q16