The fear of rising interest rates has reared its ugly head once again. Not surprisingly, utility stocks are getting hit. The market is clearly concerned about rising debt costs crimping the earnings of major utilities including Southern Company (NYSE: SO ) , American Electric Power (NYSE: AEP ) , and Consolidated Edison (NYSE: ED ) .
However, even though higher interest rates do present a headwind, none of these utilities will collapse. In fact, next year, and many years after, will produce the slow-and-steady growth that makes utilities so valuable. Put simply, underlying business conditions aren't nearly as bad as the market reaction implies.
Business-as-usual in 2013
Returns from these three utility stocks are good as 2013 draws to a close, but investors may be disappointed since the broader market is up well over 20%. To be fair though, each of these utilities are well-run and operate sound businesses. This is reflected in their respective performances so far this year.
Over the first nine months of 2013, Southern Company generated earnings, excluding one-time charges, of $2.24 per share, compared with $2.26 per share through the same period last year. Results were negatively influenced by extremely cool temperatures and heavy rainfall—in fact, Southern's service territory experienced its highest level of rain in nearly 100 years.
American Electric Power's year-to-date earnings per share in GAAP terms are down 22%, but the damage looks worse than it actually is. Results were dragged down by two separate impairment charges that totaled $144 million. Excluding these one-time items to focus on the real performance of the underlying business reveals that year-to-date operating earnings are actually up 1.5%, from $2.59 per share to $2.63 per share.
And, next year should produce reliably solid results yet again. American Electric Power expects $3.30 per share in 2014 operating earnings at the midpoint of its guidance range. This would represent 3% growth over what American Electric Power expects to earn in 2013. Plus, management showed great confidence in its future by raising its dividend twice this year.
For its part, Consolidated Edison's core ongoing operations grew 3% in the third quarter and 2% over the first nine months of the year. Along with its results, management narrowed its full-year profit forecast. This year should be another year of reliable, if unspectacular, results.
Why slow-and-steady wins the race
Despite the short-term headwinds, all three utilities are entirely confident in their own futures. These management teams understand there's nothing wrong with their underlying businesses, even if their stock prices continue to suffer as interest rates creep higher. Future earnings growth will be delivered by rate increases, population growth, and cost controls.
Southern Company spends between $6 billion and $7 billion in capital expenditures every year to ensure steady future growth, but it is maintaining strict cost controls as well. Southern projects total capital expenditures to peak at $6.7 billion this year, then decline next year and in 2015.
American Electric Power recently gave investors its strategic initiatives through 2016. All told, the company expects to produce 4% to 6% growth in operating earnings per year. This will be accomplished through a variety of initiatives, primarily well-managed capital expenditures that provide growth but avoid wasteful spending. American Electric Power set a capital budget of $3.8 billion to be held steady through 2016.
Meanwhile, in the aftermath of Superstorm Sandy, Consolidated Edison will spend $1 billion in capital expenditures through 2016 on programs intended to reduce service outages from major storms. In addition, resources will be devoted to ensuring a quicker recovery process after major storms hit.
Don't get carried away about rising interest rates
It's true that if interest rates go up, it will be difficult for utilities, which rely on debt financing. At the same time, higher interest rates are symptomatic of a better economy, and that's good news more broadly. Utilities have provided steady profits and rising dividends for decades, which include many years when interest rates were far higher than they are now.
As a result, if earning 4% to 5% dividend yields plus modest growth is your idea of a good investment, then you should consider Southern Company, American Electric Power, and Consolidated Edison.
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