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Utility Stocks

Selloff in Utility Sector Creates Buying Opportunity

By Roger S. Conrad, on Jul. 3, 2015

Utilities at Peak Health

How have utilities performed as companies? The sector is arguably at its healthiest since the 1950s, before a costly expansion phase that weakened balance sheets and drove subpar returns.

I track more than 200 essential-services companies in Conrad’s Utility Investor, the vast majority of which delivered first-quarter results that either met or exceeded management’s internal guidance.

Every earnings season, the investing world focuses on whether companies’ profits, revenues and other financial metrics lived up to Wall Street’s consensus estimates.

Although these successes and failures can drive stock performance in the short term, we prefer to focus on whether a company’s results live up to management’s guidance—the foundation on which dividend policies and capital spending plans are based.

A company that consistently meets its internal guidance usually boasts a management team that understands the business environment and communicates effectively with investors.

Conversely, names that fail to hit their guidance warrant extra scrutiny, particularly if they are repeat offenders. Only four of the more than 200 essential-services companies I track in my Utility Report Card, only four cut their 2015 guidance as a result of subpar first quarters—an impressive feat.

This strength reflects more than a dozen years of systematic de-risking among electric, gas and water utilities.

Following Enron’s implosion in late 2001, more than two dozen utilities found themselves either in bankruptcy or on the precipice of insolvency. A new generation of management teams refocused these companies on their core regulated businesses and committed to shedding riskier operations, paying down debt and repairing badly frayed relations with regulators.

These efforts enabled the utility sector to weather the 2008-09 financial crisis and the Great Recession with relative aplomb; only four of the more than 200 companies I tracked at the time cut their dividends.

And after more than six years of historically low borrowing costs, utilities have shored up their balance sheets even more by refinancing higher-cost debt and extending maturities. Management teams also continue to cut operating risk by reducing their exposure to a wholesale market challenged by depressed natural-gas prices.

The infotainment industry continues to trumpet the potential for growing adoption of rooftop solar-power units to erode utilities’ long-term viability.

However, first-quarter results from US electric utilities indicate that underlying demand for baseload power continues to grow, despite the popularity of distributed solar power in some states. This trend reflects surging use of electronics by businesses and households, coupled with conservation efforts that have picked much of the low-hanging fruit.

Meanwhile, utilities have grown their regulated rate base by acquiring and building large-scale solar-power facilities that produce four times the electricity as a similar investment in rooftop panels.

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