Vanguard Utilities ETF, a proxy for the utility sector, is up an incredible 22% so far in 2019. Utilities are generally considered slow-and-steady dividend stocks, so how is it that they are, as a group, beating the S&P 500 index, which is up around 19%? The answer is important, but you need to take a closer look at some of the names in the sector to understand what is going on at each company. And that will help you figure out if any utilities are still worth buying today.
Fear and greed
One of the core reasons that investors buy utility stocks is for safety. Utilities, by and large, sell things that we can't live without, like energy and water. And they are granted monopolies in the regions they serve, so customers can't easily switch to other providers even if they want to. In other words, if there's an economic recession, utilities should hold up well, financially speaking.
That's notable today because the current economic expansion is among the longest on record. And there are signs around the world that economic growth is slowing. Trees don't grow to the sky and economies don't expand forever, so investors have been buying assets they consider safe, like utility stocks. That's one of the core reasons for the sector's impressive run in 2019.
The problem is that utilities aren't known for speedy growth. In exchange for monopolies in the regions they serve, utilities have to get the rates they charge customers approved by government regulators. That generally means slow-and-steady increases over time, not rapid expansion. It would be a mistake to think that big share price advances are the norm here because, generally speaking, there's no fundamental reason to expect that. In fact, reliable dividend income is usually the most notable draw in the utility sector.
With that as a big-picture backdrop, you can't paint all utilities with the same brush.
Examining some big names
For example, The Southern Company (SO 0.39%) has been one of the best performers this year, up an incredible 40%. But the utility is really just a slow grower that's focused on paying shareholders a reliable dividend (it has increased the payout or held it steady for over 70 years). The dividend yield is a generous 4% or so, toward the high side for the peer group but historically low for Southern. Truth be told, it's not a particular bargain right now.
The reason for the incredible run is twofold. There's the flight-to-safety issue, but Southern is also starting to make real progress on a nuclear construction project that hadn't been going particularly well. Investors who own Southern today should be pleased, but those looking to start a position should probably sit on the sidelines for now: The utility is only targeting slow-and-steady earnings and dividend growth (the norm for the company) and the nuclear project still has a few more years to go before it's done.
Then there's NextEra Energy (NEE 1.22%), which is up 34% so far in 2019. This company is among the largest utilities in the country, with a focus on the still-growing state of Florida. However, it is also one of the largest renewable power companies in the world. The utility business is the foundation and the renewable power segment is the growth driver. Add in a rock-solid balance sheet and low payout ratio, and NextEra is offering something that most other utilities can't: growth.
With a host of projects in the works, on both the utility and renewable power sides of the business, management is targeting 6% to 8% earnings growth and an incredible 12% to 14% dividend growth rate. These are impressive numbers for a utility and investors focused on dividend growth may be willing to pay a premium here. Those with a value bias, though, won't like NextEra, which is expensive relative to peers on key valuation metrics. The utility's roughly 2.1% yield, meanwhile, is probably too small to attract those looking for yield.
Dominion Energy (D 1.71%), on the other hand, is "only" up 13%. It has clearly benefited from the flight to quality, but not as much as some of its peers. The stock's roughly 4.5% yield is near its highest levels of the past decade. The reason for this utility's relatively weak performance is that it has a heavy debt load and is pulling back on its dividend growth plans. Recently, Dominion was growing the dividend at 10% or more a year, leading to a worrying rise in the payout ratio. Now, Dominion is looking to slow dividend growth down (to the low single digits) so it can clean up its balance sheet and get its payout ratio back in line with peers. However, for investors looking to maximize their dividend income, slow and steady with a focus on fiscal prudence might be worth a close look. Although Dominion won't excite you, it appears to offer a good mix of safety and income today.
The devil is in the details
Investors looking at the utility sector need to be careful. The recent price run-up for the overall group has left some names on the expensive side, like Southern. That said, even expensive utilities may be appropriate for some investors if you understand what you are buying, which is where the dividend growth at NextEra comes in. There are still some utility names that may present value, or at least more value than peers, but you have to understand what is going on at the company level before jumping aboard. Dominion's efforts to strengthen its balance sheet and reduce its payout ratio is a prime example of this. Some utility stocks aren't worth the price they fetch today, but if you look hard enough, you might still find a few names that suit your needs, as long as you are very clear about what you are looking for.