In the wake of unexpectedly strong economic reports, increasingly confident investors are executing a “flight from safety,” which is bad news for utility stocks.
Case in point: Electric utility Dominion Resources, Inc. (NYSE:D) on Friday reported fourth-quarter fiscal 2014 operating results that missed the mark by a wide margin. The company reported earnings of $243 million and earnings per share of 42 cents, a drop from $431 million and EPS of 74 cents for the same period a year ago.
Wall Street had expected EPS of 83 cents.
That said, excluding items, operating earnings for the fourth quarter reached 84 cents per share, a year-over-year gain of 5% compared with 80 cents per share during the same year-ago quarter.
Dominion’s fourth-quarter revenue came in at $2.9 billion compared with $3.2 billion in the same year-ago quarter. Analysts’ consensus estimate had called for revenue of $3.1 billion. Dominion management gave first-quarter guidance for operating earnings in the range of 85 cents to $1 per share, below analysts’ expectations of $1.03 per share.
D stock dropped nearly 4% on Friday and was down another 1% today.
As economic and job growth accelerates, riskier equity alternatives are starting to look more appealing than “safer” income investments. Indeed, utilities took a beating on Friday and they continue to look vulnerable. The Dow Jones utility index, comprised of 15 utility companies, plummeted 4% on Friday, its worst single-day performance since August 2011.
In the U.S., in addition to robust gross domestic product gains, the employment picture continues to show strong improvement. An unexpectedly powerful employment report on Friday showed that employers had added 257,000 jobs last month and wages leaped by the most in six years, considerably better than the 230,000 jobs economists had expected.
In the face of this robust growth, investors suspect that the Federal Reserve will soon raise interest rates, which could further dampen utility stock performance. When interest rates rise, investors can obtain yields with less risk than dividend stocks, by purchasing senior (secured or unsecured) debt. Moreover, companies dependent on debt financing, such as utilities, see increases in their future interest expenses, dampening profits.
D Stock: Growing Risk
Based in Richmond, Virginia, Dominion operates via three divisions: Dominion Virginia Power (DVP), Dominion Generation and Dominion Energy. DVP is focused on regulated electric transmission and distribution that serve residential, commercial, industrial, and governmental customers in Virginia and North Carolina. Dominion Generation generates electricity through coal, nuclear, gas, oil, hydro and renewable sources. Dominion Energy centers around regulated natural gas distribution and storage.
Dominion today announced it is increasing its quarterly dividend by 7.9%, to 64.75 cents per share and $2.59 annualized. The stock’s dividend yield would grow from 3.2% to 3.5%, continuing D stock’s six-year history of dividend growth.
To be sure, Dominion enjoys several inherent strengths that should propel revenue and earnings in future quarters. The company has been boosting its capital expenditures to grow its electric and natural gas businesses and is extending operations throughout the Mid-Atlantic. The company also has been beefing up its renewable energy portfolio.
Moreover, the earnings dip in the fourth quarter should be viewed in the context of significant one-time charges, including one stemming from a law that went into effect in 2014 in the Virginia, whereby Dominion can write off 70% of the capital it has invested on nuclear and offshore wind projects over a six-year period ending Dec. 31, 2013.
However, when the economy is this good, safe assets are less appealing because they tend to underperform the broader market. It’s increasingly hard to justify the high prices currently fetched by utility stocks, which remain at risk from rising interest rates.
With a pricey trailing 12-month price-to-earnings (P/E) ratio of 29.4, compared to the trailing P/E of 19.4 for the S&P 500, D stock is a hold for now.
As of this writing, John Persinos did not hold a position in any of the aforementioned securities.