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Utilities Aren't Shut Down, But They Will Still Feel a COVID-19 Impact

By Reuben Gregg Brewer - Apr 23, 2020 at 10:31AM

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Electricity is vital for modern living, but that doesn't mean that utilities won't feel the sting of COVID-19. Here's a look at what to expect.

Most people will do just about anything to keep the lights on, the refrigerator running, and the heat going. Think back to the last long blackout you suffered through and you'll quickly understand why. That inherent demand is one of the core reasons why electric utilities are considered a relatively safe investment option. But they aren't risk free, a fact that's important to remember as earnings season is upon us and utilities start reporting the early impact of COVID-19. 

The benefits of a protected market

Early on it became obvious that having multiple electric utilities serving the same region wasn't a feasible long-term option. But one provider serving an area basically results in a monopoly, which isn't a good outcome, either. So the modern grid was built with a lot of government oversight to offset the risk that a monopoly would lead to unconstrained price increases for a product that everyone wants and, at this point, really needs.

The words safety first with a man giving a thumbs up sign in the background.

Image source: Getty Images

The relationships here change the long-term fundamentals of the utility sector a great deal. For example, there's reliable demand from locked in customers, but the rates a utility charges must be approved by regulators. So growth tends to be slow and steady over time, with the government focusing on things like reliability and the long-term supply/demand balance in a given region. Utility spending proposals generally span years at a time and hold up reasonably well in the face of recessions and less severe downturns. That makes sense given the long-term nature of the planning needed to appease regulators and the locked in customer base.

All of this goes a long way to support the view of utilities as conservative investments fit for "widows and orphans," a phrase Wall Street uses to signify the most conservative investors. As long as utilities don't load up on debt or make bad investment choices, dividend investors can usually count on a utility to keep paying its dividend in good economic times and bad. And this is also why they tend to be viewed as safe-haven investments when times get tough, allowing investors a respite from the broader storms hitting the market. But utilities aren't immune to downturns; their businesses are just better able to handle the hit.

The coronavirus is big

Which brings us to COVID-19, the global pandemic that has, at least for now, altered life as we know it. The big picture story here is that governments around the world, the United States included, have asked people to stay home and forced non-essential businesses to shut their doors. The hope is that we can slow the spread of COVID-19 by making citizens socially distance themselves. Early indications are that the effort is working as planned, but in the process entire economies have been shut down. It's highly probable that there will be a global recession. Because of the nature of what they sell to consumers, utilities are likely to hold up reasonably well. 

However, the shut down still has notable implications for utilities. The industry watcher Rocky Mountain Institute recently looked at the changes taking shape in electricity usage and estimated that, depending on the region, electricity demand could fall between 5% and 15%. The big driver here is on the industrial side, because businesses that aren't open aren't using as much power as they once were. Offsetting that a little is an uptick in consumer demand, as people are using more power because they are stuck at home. (Peak demand times are shifting a little, as well.) Different regions are being impacted differently depending on the customer base and the types of industries operating in the area. 

For example, Dominion Energy (D 0.98%) has for years seen increased demand from data centers because of the regions it serves. In fact, it is a constant point of discussion on conference calls. During Dominion Energy's fourth quarter 2019 analyst call, for example, the company specifically noted that it added 26 data centers in Virginia -- a record number. That's a key underpinning for the projected 1.2% demand growth projection for the region. With more people working from home, electricity demand from data centers should hold up well. It's not unreasonable to expect the demand hit, and thus the sales and revenue impact, to be somewhat muted for Dominion Energy.

There are other utilities that are also well positioned, like Consolidated Edison (ED 0.36%). The company largely serves the New York City metro area, which would seem like a net negative. Indeed, with the city largely shut down, electricity use by businesses is probably set to plummet. However, Con Ed, like some of its peers, has started charging customers for its delivery services (the use of its poles and wires), essentially passing the costs of electricity directly through to customers. The core of its earnings are the service charges that have to be paid regardless of the amount of power used. So, it's likely that Con Ed's bottom line will hold up reasonably well even as the city that never sleeps looks like it is snoozing. 

That said, the demand decline from social distancing mandates is still a big issue to watch. Take, for example, The Southern Company (SO 0.92%), which operates in the Southeastern United States. In 2019 electricity usage by residential customers was roughly a third of its total business. Industrial and commercial customers made up the rest, split about evenly. So two-thirds of its demand base was directly impacted by the government's efforts to combat COVID-19. It wouldn't be surprising to see Southern take a bigger top- and bottom-line hit than some of its peers. For reference, customers designated as commercial and industrial only made up about 20% of Con Ed's electric usage in 2019.   

There is one longer-term issue to watch in all of this. Utilities should maintain their track record as good widows and orphan stocks as long as the shutdowns don't drag on for an extended period (think something like a year) or lead to drastic fundamental declines in electricity consumption. Because of the nature of these businesses and the relatively high shareholder payouts in the industry, many utilities don't carry a lot of cash on their balance sheets. Thus, they could have difficulty adjusting to extreme and long natured changes without making downward adjustments to their dividends. There's no telling what happens in the future, of course, but if history is any guide the world will figure out a way to deal with this pandemic and return to something close to "normal." So, for now, there's no particular reason to believe that utilities are headed for a massive market upheaval, but it is something to keep in the back of your mind.

Protected, not immune

The big takeaway here is that the basic utility model provides for strong underlying demand, and growth and spending that are somewhat outside of the typical economic cycle. That allows these companies, generally speaking, to hold up in the face of adversity. However, that doesn't mean that utilities won't be impacted by what is going on around them. COVID-19 is an extreme event and it will definitely have wide-ranging impacts for the economy and utilities. Investors should expect these safe haven stocks to see top- and bottom-line weakness in the near-term, though some will be better positioned to deal with the impact than others based on their individual situations. Conservative long-term investors shouldn't get too caught up in the near-term fluctuations, though those that have bought into the sector in search of a safe port in a storm might want to dig a little deeper to make sure the utility they own is really as safe as they think it is.

Reuben Gregg Brewer owns shares of Dominion Energy, Inc and Southern Company. The Motley Fool recommends Dominion Energy, Inc. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Consolidated Edison, Inc. Stock Quote
Consolidated Edison, Inc.
$98.86 (0.36%) $0.36
Dominion Resources, Inc. Stock Quote
Dominion Resources, Inc.
$82.19 (0.98%) $0.80
The Southern Company Stock Quote
The Southern Company
$77.90 (0.92%) $0.71

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