Utility stocks are often viewed as bond proxies with their relatively stable yields. As a group, they suffered a decline after the 2016 elections as investors moved toward a more risk-on strategy.
Utilities were sold off in the second half of 2016 under the presumption that they were too safe. A stronger economy would mean opportunities for gains beyond what utilities would offer.
But the stability and consistent yields delivered have pushed the Utilities SPDR (ETF) (NYSEARCA:XLU) up over 11.8% year-to-date. Even though a rising interest rate environment is likely to hurt utilities as their capital expenditures require new debt issuance, the race for yield has prevailed.
Below are three utility stocks that prioritize yield and balance underlying growth.
Utility Stocks to Buy: CenterPoint Energy, Inc. (CNP)
Both CenterPoint Energy, Inc.’s (NYSE:CNP) core electric transmission and natural gas distribution businesses have demonstrated not only resilience but also growth.
Second-quarter earnings showed strength in both segments. Customer growth — electric transmission added 52,000 metered customers year-over-year and natural gas added 32,000 metered customers year-over-year — resulted in an overall 43% increase in business operating profits.
Rate relief has also been an earnings driver. Since there are limits to what utilities may charge customers, if prices are such as the company will incur a loss, that company may apply for rate relief. On this front, CNP was able to collect $11 million for electric transmission and $6 million for natural gas distribution during the second quarter. In the quarter prior, $14 million and $13 million for electric transmission and natural gas distribution, respectively.
In the quarters to come, the primary drivers will be much of the same in the way of low single-digit customer growth and rate relief. However, there is potential for additional upside with the Atmos Energy Marketing acquisition already accretive YTD and the possible sale of the Midstream business. A spin off has been ruled out as it would not allow the spin off entity to maintain certain credit standards, but a sale is still on the table with multiple parties currently in the due diligence process.
Utility Stocks to Buy: Southern Co (SO)
Southern Co (NYSE:SO) boasts 15 years of consecutive dividend increases, delivering consistent shareholder returns from its diversified energy operations across natural gas, coal, nuclear, renewables and hydro.
Growth in the core natural gas business, a highly contracted midstream business and complementary gas marketing services make and a 4.7% yield.
SO is one of the largest natural gas distribution operators in the U.S. with seven state-regulated local distribution companies (LDCs). Naturally, natural gas accounts for the bulk of its business with an expected base case CAGR over the next two years of 5%. Catalysts abound for natural gas and other business segments.
Strong relationships with regulators in its LDC jurisdictions coupled with LDC infrastructure investment program growth will support growth numbers as will customer additions, which management estimates at 1% annually given positive economic outlooks across its jurisdictions.
A rebound in LDC costs is also not out of the question, which would be a tailwind for earnings.
SO’s pipeline investments in midstream operations also boast favorable economics with lower risk. Almost $3 billion has been invested across six pipelines, half of which are in-service. As the remainder become operational, net income for the segment should more than double. By 2020, management thinks they can grow what was a $31 million net income business last year to $87 million.
ROEs average 11-12% with long contractual periods. The pipelines under construction have contracts ranging from 14 to 25 years with creditworthy counterparties (over 90% of capacity is under contract with investment-grade parties).
Utility Stocks to Buy: Entergy Corporation (ETR)
Entergy Corporation (NYSE:ETR) is an integrated energy company that has interests in production and retail distribution. It owns and operates power plants (about a third of capacity comes from nuclear power), serving communities in Arkansas, Louisiana, Mississippi and Texas.
In order to deliver top-quartile returns for shareholders, ETR is implementing a strategy that is focused and simple: grow the predictable utility business while managing risk in other areas like wholesale. With earnings from the steady utility business, ETR is committed to its long-term dividend growth aspiration.
Current yields are already at over 4%, and while second-quarter earnings were a bit lumpy due in part to the wind down of the wholesale commodities business, net revenue increased quarter-over-quarter.
Don’t be discouraged, however, by the likely continuation of lumpy results in coming quarters. As ETR continues to reduce risk via the sale of plants in the wholesale business, lumpiness is to be expected. The benefits from this de-risking will position ETR better down the line to meet its long-term goals as will the construction of the Lake Charles Power Station and the Montgomery County Power Station, which Entergy recently got the green light for.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.