Investors shun utility stocks in 2023.
Investment portfolios used to heavily rely on utility stocks, which were considered a safe bet in the stock market. These stocks historically offered low risk and high yield. However, the landscape has changed.
Unlike growth stocks, utility stocks were popular among investors looking for steady dividends. Unfortunately, these once-reliable dividends have dried up. What caused this shift? And just how risky are utility stocks in 2023?
Utilities: Traditionally Stable
When it comes to lower-risk investments, many investors turn to utility stocks. After all, electricity is a necessity that people can’t live without. Regardless of the economy, consumers will always need to turn on the lights and heat their homes.
Most utilities are regulated by state or federal policymakers, creating a higher barrier for competitors to enter the market and offer lower rates. In the United States, utilities operate as regional monopolies and are publicly traded.
Due to their reliable dividends and high yield, utility stocks have been a staple in many investment strategies.
Utilities Help S&P 500 Fall in Third Quarter 2023
The S&P 500 Index took a hit in the third quarter of 2023, primarily driven by sectors affected by inflation and higher interest rates. This included consumer staples, real estate, and utilities.
Among these sectors, utilities experienced the second-largest loss in the index, with a 10.09 percent drop throughout the quarter. Leading the decline were AES Corporation (AES), down 26.68 percent, and NextEra Energy (NEE), down 22.79 percent.
However, the downward trend for utility stocks was far from over.
Utility Sector Continues Decline
As of the first week of October 2023, the S&P 500 utility sector had plummeted by 21 percent, experiencing a 12 percent drop in just two weeks. This underperformed the broader index, which saw an 11 percent gain.
NextEra Energy suffered a further decline of 52 percent, while AES Corp. lost 37 percent.
Moreover, the once-healthy dividends provided by utility companies are disappearing. NextEra Energy Partners, a subsidiary of NextEra Energy, slashed its dividend forecasts in half. This raises concerns among investors about the parent company’s earnings growth due to its subsidiary’s downward spiral.
The utility sector hasn’t experienced such a setback since 1999, when it fell 9 percent during the dotcom bubble burst.
So, what caused this downward turn? There are several factors contributing to the nosedive in the utility sector.
US Treasury Notes Climb
Utility stocks typically attract investors with their dividends, which have historically hovered around 5 percent, offering low-risk and high-yield returns.
For the past 15 years, the utility sector has averaged about 1.05 percent points higher than the 10-year U.S. Treasury note, rewarding conservative investors for taking on the added risk of utility stocks. However, the yields have changed.
Risk-free Treasurys have seen rising interest rates, with two-year Treasurys reaching 5.1 percent and the 10-year note around 4.8 percent.
Conservative investors now have the option to purchase risk-free Treasurys and achieve similar returns to what they were seeing with utility stocks.
Inflation Hurts Utilities
High inflation rates have a significant impact on utility companies’ borrowing costs. While this affects all businesses, it poses a major issue for utilities due to their typically high debt levels.
Utility firms have substantial capital expenditures and high debt-to-market cap ratios. Maintaining and expanding utilities, especially renewable energy projects and power grid upgrades, require significant financing.
While passing on the higher costs to customers is an option, regulations often prevent this. As a result, equity investors and bondholders end up bearing the costs.
All these factors make utility companies less attractive to investors.
Fires Destabilize Utility Stocks
Utility companies have been hit hard by the abundance of fires, which not only destroy homes and buildings but also devastate a utility’s infrastructure.
Furthermore, utility companies have faced blame for fires or at least exacerbating them. For example, Hawaiian Electric saw a collapse in its share price, plunging by 65 percent, due to potential litigation regarding its equipment’s role in spreading a fire.
In 2019, California utility PG&E filed for bankruptcy following a series of costly fires, with outdated equipment being blamed.
Utilities Decline Could Be an Opportunity
Despite the current decline, utilities remain an essential industry. People will always need electricity and heating in their homes. In fact, after the dotcom bubble burst in 2020, utilities saw a 57 percent gain while the S&P 500 dropped by 9 percent.
Therefore, in hindsight, the bottom of the market decline presented a great buying opportunity for utility stocks.
However, it remains uncertain how long it will take for the utility sector to recover. With ongoing inflation and high Treasury rates, many investors may adopt a “wait and see” approach.
The Epoch Times copyright © 2023.
The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
How does rate regulation affect the ability of utility companies to set prices for their services?
Additionally, utilities are often subject to rate regulation, meaning they have limited control over the prices they can charge customers. As a result, they may struggle to cover their increased borrowing costs, leading to a decline in their profitability and, ultimately, their stock prices.
Renewable Energy Competes
The rise of renewable energy sources, such as solar and wind, has also played a role in the decline of utility stocks. As these technologies become more cost-effective and efficient, they are increasingly seen as viable alternatives to traditional utilities. This has led to increased competition for utility companies, further pressuring their profitability.
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