Sector investing offers targeted opportunities into the stocks of companies in specific segments of the economy. The utilities sector includes companies such as electric, gas, or water utilities or those that operate as producers or distributors of power. As of July 2022, the utilities sector boasted a market capitalization of over $1.58 trillion. Although utilities are private, for-profit companies, they are part of the public service infrastructure and are heavily regulated. Those who include utilities in their portfolios hold them as long-term investments, commonly leveraging their stable dividends for regular income.
Key Takeaways
- The utilities sector includes the stocks of companies such as electric, gas, and water utilities.
- Investors commonly buy utilities as long-term holdings.
- The sector is often used as an investment during economic downturns.
- Challenges for the sector include regulatory oversight and costly infrastructure updating and maintenance.
- Clean energy initiatives have some analysts forecasting strong growth for the utility industry in the 2020s.
Understanding the Utilities Sector
Utilities include large companies that offer multiple services such as electricity and natural gas or specialize in just one type of service, such as water. Some utilities rely on clean and renewable energy sources like wind turbines and solar panels to produce electricity.
Utilities typically offer investors stable and consistent dividends, coupled with less price volatility relative to the overall equity markets. As a result, these investments tend to perform well during recessions and economic downturns. Conversely, utility stocks tend to fall out of favor during times of economic growth.
Utilities require a significant amount of expensive infrastructure and consequently carry large amounts of debt on their balance sheets. These debt loads make utilities hypersensitive to changes in the market interest rate. They require continuous inflow of funds to finance infrastructure upgrades and new asset purchases.
As of July 2022, higher inflation raised new challenges for utilities. The inflation of the past decades saw utilities face large debt, soaring fuel costs, blackouts, increased regulation, and even bankruptcies. Utilities that succeed through economic challenges remain some of the best investments for safety, generous income, and steady wealth-building.
Though the sector attracts a wide range of investors, utilities companies commonly attract income-focused investments.
How Investors Trade Utilities
Because utility stocks pay reliable dividends, they are often favored over lower-dividend paying equities. In the wake of the financial crisis, the Federal Reserve cut interest rates to stimulate the economy. As a result, investors flocked to utilities as safer investments, viewing utility companies as a viable defensive choice during macroeconomic downturns.
Where higher interest rates pose a risk, investors can find higher-yielding alternatives than utilities. When a utility pays a dividend yield of 3% but interest rates raise Treasury bond yields to 4%, the utility must either increase its dividend payout rates or fall out of investor favor.
Aside from investing in the individual stocks of utility companies, investors may purchase regional utilities or invest in exchange-traded funds (ETFs) or sector funds containing a basket of utility stocks of companies located throughout the U.S.
Two noteworthy mentions:
- The Fidelity Select Utilities Portfolio (FSUTX) held 29 utility companies as of March 2022 with an annual dividend yield of 1.52%.
- The Utilities Select Sector SPDR Fund (XLU), one of the largest utility sector funds, boasted $15.5 billion in net assets and was an actively traded utility ETF, with over 18 million shares traded daily. The fund typically paid a dividend yield of around 3%.
The XLU’s dividend yield surpassed the yield for the S&P 500 equity ETF, SPDR S&P 500 Trust ETF (SPY), which paid around 1.56% as of July 2022.
Pros and Cons of the Utilities Sector
Utilities are stable investments that commonly provide a regular dividend to shareholders, making them a popular long-term buy-and-hold option. Dividend yields on utility stocks often trend higher than those offered by other equities.
During economic downturns with low interest rates, utilities become attractive due to their lower volatility and desirable source of predictable investment returns derived from the dividends they pay on their shares. Profit margins for utilities can vary depending on their location and regulations.
On the flip side, utilities face intense regulatory oversight and require expensive infrastructure that demands routine updating and maintenance. To meet these infrastructure needs, utility companies often have extensive debt products, leading to greater sensitivity to interest rate fluctuations. Any rise in rates would mean the company must offer higher yields to attract more bond investors.
Pros
- Stable, long-term investments due to consistent dividend returns
- Safe investments during economic downturns
- Diverse investment options like individual stocks, ETFs, and bonds
Cons
- Intense regulatory oversight
- Ongoing infrastructure upgrading and maintenance demands
- Become less attractive when interest rates and bond yields are high
Public Utility Companies
The utilities sector consists of companies that provide electricity, natural gas, water, sewage, and other services to homes and businesses. Public utilities, which are privately owned yet heavily regulated, fall under the supervision of public utility commissions typically at the state level.
NARUC, the National Association of Regulatory Utility Commissioners oversees these commissions, ensuring reliable utility service at fair and reasonable rates. Prominent utility companies in the United States with substantial investor interest include:
- NRG Energy (NRG): An integrated power company generating electricity and providing energy solutions and natural gas across the U.S. and Canada
- OGE Energy Corp (OGE): A holding company with investments in energy services, providing physical electricity delivery in Oklahoma and Western Arkansas
- PG&E (PCG): Facilitates electricity and natural gas sales and delivery mainly within California
How the Utilities Sector Is Changing
In 2020, President Joe Biden called for a 100% clean energy economy and net-zero greenhouse gas emissions no later than 2050, committing nearly $2 trillion for this aim. The energy and utility industry has the opportunity to advance its grid modernization and clean energy efforts using funds allocated through the Infrastructure Investment and Jobs Act, which earmarked $65 billion for national power infrastructure upgrades.
A 2022 industry outlook report by Deloitte identified five key trends: enhanced competition, infrastructure expansion, greater electrification of transportation, disaster readiness, and traditional energy players entering the renewable energy field.
Douglas Simmons, a portfolio manager with Fidelity utilities, indicated robust fundamentals in 2022 driven by the shift towards renewable energy sources. However, while wary of potential regulatory impositions that could force power plant closures, the sector largely supported tax credits proposed in the Build Back Better bill—later replaced by the Inflation Reduction Act (IRA), which includes $369 billion for climate and clean energy initiatives aimed at reducing costs related to the renewable energy transition for utilities.
How Quickly Are Renewable Energy Resources Growing?
According to Morgan Stanley, renewable energy resources are expected to grow dramatically from making up 12% of the U.S. energy mix in 2021 to 39% by 2030.
What Is a Public Utility?
Public utilities, regulated by government or state agencies such as NARUC, commonly supply essential services including electricity, gas, and water to specific regions or areas.
What Is the Largest Utility Company?
Globally, the largest utility company is NextEra Energy, valued at a market capitalization of $158B as of July 2022. Its principal subsidiary, FPL, is primarily engaged in the generation, transmission, distribution, and sales of electric energy.
The Bottom Line
The utilities sector constitutes an essential category of industrial stocks inclusive of companies supplying everyday basic amenities like natural gas, electricity, and water. Typically, investors buy these stocks for long-term holdings thanks to their stable prices and appealing dividend incomes. The movement towards clean energy, coupled with competition-enhancing legislation and policies favoring renewable sources, forecasts strong growth for the utilities sector in the coming years.
Related Terms: dividends, market capitalization, renewable energy, economic growth, infrastructure, debt loads, bankruptcy, interest rate, instant credit quotes, financial crisis.
References
- Fidelity. “Utilities”.
- Forbes. “Utilities Will Beat Inflation in 2022”.
- Board of Governors of the Federal Reserve System. “The Federal Reserve’s Policy Actions During the Financial Crisis and Lesson for the Future”.
- Fidelity. “FSUTX”.
- Fidelity. “Detailed Quote: XLU”.
- National Association of Regulatory Utility Commissioners. “About NARUC”.
- Biden-Harris Campaign. “The Biden Plan For a Clean Energy Revolution and Environmental Justice”.
- PWC. “Infrastructure Bill Impacts on Energy & Utilities”.
- Deloitte. “2021 Power and Utilities Industry Outlook: Exploring Energy Industry Trends”.
- Fidelity. “A Power Shift for Utilities Stocks”.
- Climate Wire. “Utilities Vow to Work With Biden on ‘Build Back Better’”.
- The White House. “FACT SHEET: How the Inflation Reduction Act Builds a Better Future for Young Americans”.
- Bloomberg. “Coal to Exit From U.S. Power System by 2033, Morgan Stanley Says”.
- NextEra Energy. “Work”.
- Fidelity Investments. “NEE”.
