Utility stocks have been relatively volatile in the recent past. However, most utility stocks have a low beta and have a stable cash flow visibility. Utility stocks should therefore be a part of the core portfolio as they reduce the portfolio risk.
Mark D. Schild, assistant dean at the Stillman School of Business at Seton Hall University, said utility stocks tend to have high levels of debt and are sensitive to interest rate movements. He discussed utility stocks in an e-mail to InvestorPlace:
“Despite the high debt levels, the industry knows how to manage its balance sheet and couple that with typical 20-year power-purchase agreements for many projects (especially the renewables area) and there is stable, easily forecastable cash flow. This is especially important in weaker economic times. In addition, the sector tends to be defensive since people pay their utility bills as a priority to keep the lights, HVAC and wi-fi running.”
And as we move forward, the question of sustainable energy is becoming more and more of a topic among utilities. There’s a greater interest in renewable energy, such as wind and solar power.
That’s a lot to think about for a sector that’s generally looked at as, honestly, a little boring. But with this overview in mind, let’s take a look at four utility stocks worth considering:
- American Water Works (NYSE:AWK)
- NRG Energy (NYSE:NRG)
- Algonquin Power & Utilities (NYSE:AQN)
- Dominion Energy (NYSE:D)
Best Utility Stocks to Buy: American Water Works (AWK)
AWK stock is attractive with the company being the largest and most diverse water utility company in the United States. The stock is also attractive considering a low beta of 0.2 coupled with a dividend payout of $2.20 per share.
Another interesting fact about AWK stock is that returns in the last one year have been 25.8%. Furthermore, in the last five years, the stock has delivered returns of 188%. Clearly, there has been steady value creation.
From a growth perspective, the company believes that as U.S. water infrastructure deteriorates, there is ample scope for investment and growth. The company plans to invest $8.8 to $9.4 billion by 2024.
Earnings growth will therefore keep the stock attractive. Analyst estimates suggest that earnings growth for the company is likely to average 8.1% annually over the next five years.
Another factor that can accelerate earnings growth is acquisitions. The water utilities industry is relatively fragmented. American Water Works is looking for industry consolidation opportunities. With financial flexibility, acquisitions can trigger earnings growth and stock upside.
Overall, AKW stock is attractive with a steady growth outlook, low beta, strong fundamentals and consistent dividend growth.
NRG Energy (NRG)
In the electrical utilities segment, NRG stock is worth considering at current levels. In the last year, the stock has moved lower by 2%.
After an extended period of consolidation, I believe that NRG stock is due for an upside. Nine analysts have provided a median price target of $42 for the stock. This implies a upside potential of 24% from current levels in the next 12 months.
In a recent news, NRG Energy acquired Direct Energy from Centrica (OTCMKTS:CPYYF). The company believes that this acquisition will add $740 million to the annual EBITDA besides providing regional diversity.
Further, NRG stock has a current dividend of $1.20 per share with an attractive dividend yield of 3.5%. Prior to the acquisition, the company had planned an annual dividend increase of 7% to 9%. It can be potentially higher as inorganic growth adds to the cash flows.
In May 2019, the company acquired Stream Energy’s retail electricity and natural gas business. Therefore, it’s a part of the company’s strategy to pursue inorganic growth. With strong fundamentals, continued acquisitions are likely to accelerate earnings growth.
Algonquin Power & Utilities (AQN)
Among utility stocks, Algonquin Power is also worth considering for the long term. AQN stock has been subdued with returns of 8% in the last one year. However, I believe that a breakout on the upside is imminent and current levels are attractive for accumulation.
The first reason to like AQN stock is the company’s attractive dividend. Currently, an annual dividend of 62 cents per share implies a dividend yield of 4.5%. Further, analyst estimates point to an annual average earnings growth of 8.3% over the next five years. This provides scope for steady dividend increase.
For the current year, the company is lowering capital investment plans due to the novel coronavirus pandemic. However, the company has maintained the guidance of $9.2 billion in capital investments over the next five years.
As these investments are made in the coming years, steady revenue and earnings growth will follow. The company expects annual EBITDA growth of 15% through fiscal year 2024. As EBITDA grows, the company’s cash flows will also swell.
Algonquin also entered the water utility segment with the acquisition of New York operations of American Water Works. In the coming years, this segment can provide an additional growth trigger.
Dominion Energy (D)
Dominion Energy is a company that’s in a transformation phase and it’s the key reason to consider exposure to D stock. The stock has been sideways for the current year and a breakout is likely after the consolidation.
Dominion is making a big transition to renewables. The company is already the third-largest utility company owner of solar in the U.S. Furthermore, between 2019 and 2035, the company’s renewable generation capacity is expected to grow at a CAGR of 15.4%.
This transformation is likely to yield results in the long-term as focus on cleaner energy increases. On the flip side, the company’s dividends are expected to be reduced in -sync with asset sales. However, I believe that this negative will be more than offset by the long-term vision.
Further, the company’s balance sheet and credit metrics have improved. Beyond the current transformation phase, dividend growth will resume.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
