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Utility stocks are among the core holdings in most income-oriented portfolios. There are good reasons why. They’re stable, offer a dependable yield, and in most cases, increase their payouts yearly. Fortis and Canadian Utilities both boast a half-century of annual dividend hikes.
But there are two problems with these securities. The first is that they have limited capital gains potential. As regulated companies, they don’t have control over a large portion of their revenues. The rates they can charge are fixed by government agencies. So, investors shouldn’t expect to see big gains from these stocks.
The second drawback is that utilities are highly interest-rate sensitive. They invest large amounts of money in building and maintaining distribution networks, which makes them capital-intensive. When rates rise, the cost of carrying debt increases, impacting the bottom line.
That’s one of the reasons the price of utility stocks tumbled when the Bank of Canada started to push rates higher in 2022 to combat inflation. Despite speculation of interest rates cuts starting as early as this month, these stocks still haven’t shown much movement. As of the close on May 31, the S&P/TSX Capped Utilities Index was down by a fractional 0.51% year to date.
But something strange is happening south of the border. U.S. utility stocks have become one of the hottest sectors of the market. The S&P 500 Utilities Index is up 14.15% year to date, outperforming the broader S&P 500 index. What’s going on?
Artificial intelligence is what’s going on. Investors expect technology companies to spend billions of dollars in the coming years to build networks of data centres to meet corporate and consumer demand for AI driven services. Those data centres will require huge amounts of power to operate – power that’s not yet available.
Investors seem to feel that utilities with exposure to clean energy and nuclear power will be the main beneficiaries of this new trend. In some cases, the surge in share prices is unprecedented. For example, Texas-based Vistra Corp. (NYSE: VST) has seen its share price jump 160% so far this year. That’s unheard of in the utilities’ world. Baltimore-based Constellation Energy Corp. (NSD: CEG) is ahead 89%, while Houston-based NRG Energy (NYSE: NRG) has gained 58%. All these companies have exposure to clean energy and nuclear power.
There is no Canadian public company that fits the profile of these big U.S. movers. All our nuclear facilities are provincially owned, with Ontario Power Generation the largest operator. TC Energy (TSX: TRP) is part of a partnership that operates the Bruce Nuclear Generating Station, but that’s only a small part of its business, and the stock is flat so far this year.
So, where to look? I don’t advise chasing the big U.S. gainers at this point. VST has a p/e ratio of 53.29, which is ridiculously high for a utility. The shares yield only 0.99%. CEG has a p/e of 29.12 and a yield of 0.63%. NRG is better, with a 11.42 p/e and a 2% yield.
However, there is one company that I do prefer. It has some of the same attributes as the big movers and a more realistic price point.
The Southern Co. (NYSE: SO), based in Atlanta, Georgia, was founded about a century ago. It supplies power to customers in Georgia, Alabama, Mississippi, and north Florida. Its facilities range from fossil fuel plants (mainly coal and natural gas) to clean energy and nuclear. Its four Vogtle reactors, the last of which recently came on-line, comprise the largest generator of clean energy in the U.S., and are expected to produce more than 30 million megawatt hours of electricity each year.
Southern expects to add 9.5 GW in electricity production capacity between now and 2030. About 80% will be in non-carbon-emitting technologies, with solar power at the top of the list. The company’s goal is to reach net zero greenhouse gas emissions by 2050, with a 50% reduction by 2030.
Southern has a market capitalization of $87 billion and trades an average 4.7 million shares per day. And the stock had been bumping along in the $60-$70 range (figures in U.S. dollars) for most of this year until it started to push higher in April. It’s up about 13% year-to-date.
First-quarter results were impressive. The company reported net income of $1.13 billion ($1.03 per share), up from $862 million ($0.79 per share) in the same period last year.
“All our businesses experienced a strong start to 2024,” said CEO Christopher C. Womack. “This performance was driven by a variety of factors, including investments in our state-regulated utilities, weather that was less mild than the first quarter of last year, and higher weather-adjusted sales in our electric utilities’ commercial customer class, a fact that speaks to strong local economies and increased usage by many existing data centre customers.”
The company is guiding towards earnings per share between $3.95 and $4.05 this year.
In April, the board of directors approved an $0.08 per share annual dividend increase, to $2.88 per year. It’s the 23rd consecutive year that the dividend has been increased. The shares yield 3.6% at the new rate. As Southern is a U.S. company, its dividends are subject to a 15% withholding tax for Canadian investors unless the shares are held in a retirement account.
The company operates in an economically dynamic region, has a strong environmental commitment, and pays a respectable dividend, making it attractive for income-oriented portfolios. As always, consult with your financial advisor before investing to ensure the stock aligns with your financial objectives and risk tolerance.
Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website.
Follow Gordon Pape on X at X.com/GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney.
Notes and Disclaimer
Content © 2024 by Gordon Pape Enterprises. All rights reserved. Reprinted with permission. The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.
Image: iStock.com/vencavolrab
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