Utilities to protect from virus volatility

These three companies are a source of stability in uncertain times

Vikram Barhat 5 February, 2020 | 1:26AM
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The outbreak of the coronavirus has spooked industries and investors across the globe as the total number of coronavirus cases in China has now officially surpassed the total number of worldwide cases of the deadly SARS virus. The perception of risk has forced sweeping cancellations including many flights to China,  the Beijing Winter Olympics 2022 test event, and a shutdown of Apple and Starbucks stores in China as a preventive measure.

Leading U.S. companies already warning about the potential fallout of the China virus on earnings calls are keeping stock markets on edge. As investors grapple with the negative news loop and stock market losses, this may be a good time to bring relatively unglamorous but stable utility stocks to the front of the screen.

Utility companies provide a defensive play at times of market downturn. The rationale is that people tend not to cut spending on gas and electricity, thus keeping utility companies relatively immune from the vagaries of stock markets. In fact, the sector has jumped more than 5% in the S&P 500 in January, as of Jan 29. Not surprisingly, the following names are trading above their fair values. However, a pullback could create an attractive entry point.

American Water Works Co Inc

 

Ticker:

AWK

 

Current yield:

1.47%

 

Forward P/E:

34.72

 

Price

US$135.98

 

Fair value:

US$96

 

Value

41% premium

 

Moat

Narrow

 

Moat Trend

Stable

 

Star rating

*

Data as of Jan 29, 2020


The largest investor-owned U.S. utility, American Water Works (AWK) provides water and wastewater services to approximately 3.5 million customers, including military bases, municipalities, oil and gas exploration, across 16 states. Regulated markets account for more than 90% of earnings.

The pure-play water utility has increased earnings at a low-double-digit pace since its IPO in 2008, surpassing most of its peers. “The earnings growth has rewarded investors with a total return of over 500% in the 11 and a half years since the spin-IPO by German utility RWE,” says a Morningstar equity report.

Improving regulatory frameworks, increasing operations and maintenance efficiency and acquisitions have underpinned the firm’s earnings growth. American Water recently reported adjusted quarterly earnings of US$1.33 per share versus US$1.20 in the same period last year, boosted “entirely due to strong regulated results,” says Morningstar equity analyst Charles Fishman, who recently raised the stock’s fair value from US$93 to US$96, and projected EPS growth of 9.4% over the next five years, topping most regulated utilities.

Utilities are trading at multi-decade high price/earnings multiples, but American Water trades roughly 50% higher than the average P/E of regulated electric utilities, cautions Fishman. On the bright side, though, the utility has been accelerating its dividend increases, averaging over 10% per year for the past few years. “We expect an annual dividend-growth rate of 10% for the next five years,” says Fishman, noting that “there is room to increase the dividend modestly faster than earnings growth.”

Ameren Corp

 

Ticker:

AEE

 

Current yield:

2.47%

 

Forward P/E:

23.15

 

Price:

US$80.92

 

Fair value:

US$66

 

Value:

22% premium

 

Moat:

None

 

Moat trend:

Stable

 

Star rating:

**

Data as of Jan 29, 2020


A public utility company, Ameren (AEE) delivers electricity to nearly 2.5 million customers, and natural gas to roughly 1.0 million customers, in Missouri and Illinois.

After operating for years in one of the most difficult regulatory environments, the company is benefitting from improved and constructive utility legislation in both its regulatory jurisdictions. “Management’s patient, yet persistent years-long efforts resulted in increased investment opportunities across the territory, a stark change from just one year ago,” says a Morningstar equity report, noting that continued execution and support from regulators could add to the firm’s competitive strength.

As a result of more favourable regulatory framework in Missouri, management is keeping its promise of capital investment in supportive jurisdictions. “Ameren is allocating US$6.8 billion of its US$13.3 billion five-year investment program in Missouri, long the recipient of minimal investment,” says Morningstar equity analyst Andrew Bischof.

The utility is committed to upgrading aging and underperforming assets, employing smart grids and connected grid services, and improving its focus on renewable energy. Ameren is pushing to meet its goal of 700 megawatts of wind energy generation this year in Missouri, with an investment of approximately US$1.2 billion. “Ameren has received regulatory approvals for the full investment, as well as executed interconnection agreements,” says Bischof, adding that the company is also looking to install 100 MW of solar by 2027.

While the utility lacks an overall economic moat, “Ameren’s transmission assets are moaty,” as capital costs for new transmission lines are too high and Ameren benefits from regulatory protection, asserts Bischof, who recently upped the stock’s fair value from US$62 to US$66.

Dominion Energy Inc

 

Ticker:

D

 

Current yield:

4.45%

 

Forward P/E:

19.34

 

Price:

US$85.24

 

Fair value:

US$86

 

Value:

Fairly valued

 

Moat:

Wide

 

Moat trend:

Stable

 

Star rating:

***

Data as of Jan 29, 2020


Virginia-based Dominion Energy (D) produces and transports natural gas and electricity. The integrated energy company generates 31,000 megawatts of electricity and operates one of the nation’s largest natural gas storage systems.

Dominion’s offshore and onshore wind projects and proposed solar projects appear to have strong policy support from Virginia state that has set a goal of 30% renewable and nuclear energy by 2030 and 100% by 2050.  “In our opinion, Dominion’s offshore wind project has some advantages compared with the difficulties offshore wind developers are having in New England,” says a Morningstar equity report, pointing out the firm’s offshore project is located on federal land entirely locked up in leases by Dominion, as well as the construction site doesn’t interfere with fishing.

Further, Dominion has accelerated its capital expenditures with growth investments expected to be roughly US$26 billion over the next five years, about two-thirds of those tied to its regulated utility in Virginia. “Including maintenance capital expenditures, we expect total capital expenditures and equity investments in Atlantic Coast Pipeline [of which it owns 48%] to reach US$35.5 billion from 2019-2023,” says Fishman, adding “this should drive EPS growth over 5% annually.”

The wide-moat firm reported solid third-quarter earnings and made a strong argument for the potential of its offshore wind project proposal, prompting Fishman to raise the stock’s fair value from US$84 to US$86. Dominion’s sustainable competitive advantage stems from the fact that its regulated gas and electric utilities enjoy some of the most constructive regulation and attractive growth potential in the country.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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