US utilities, renewables stock selloff underscores concern over spending plans

The recent utilities and renewables stock price selloff, driven largely by higher interest rates, should not do long-term damage to either sector, industry analysts said.

Since NextEra Energy Partners (NEP) announced a cut to its limited partner distribution per unit growth on Sept. 27, prompting selloffs at both the limited partnership and NextEra Energy Inc., which formed the yieldco, the S&P 500 Utilities Index and the S&P Global Clean Energy Index have both fallen about 7% as of the Oct. 4 market close, compared to the 10-year US Treasury yield's nearly 4% gain.

Scotiabank analysts in an Oct. 4 report attributed the selloff to growing investor fears, "about companies' abilities to attractively raise capital needed to finance spending and therefore drive rate base/earnings growth. Relative to even a week ago, the cost of debt and the cost of equity for US utility companies has increased notably."

"We argue that utility stocks shouldn't be so yield sensitive given the historically fast growth, but the market clearly disagrees," they continued.

Still, the selloff does create opportunities for investors as "some utilities have valuations that haven't been this attractive in a decade," according to analysts at Morningstar.

"Inflation and higher interest rates have cooled a decade of abnormally high valuations, but utilities' fundamentals are better than they have been in decades," they wrote Oct. 4. "Earnings growth for many utilities is robust. Balance sheets are strong. Dividends are well covered and growing."

Scotiabank and KeyBanc Capital Markets both named Michigan electric and gas utilities CMS Energy Corp. and DTE Energy Co. as "high quality" and "defensive" stocks during the downturn.

NextEra shares have plummeted 22.5% since Sept. 27 to close at $50.62 on Oct. 4, but Wells Fargo analysts still believe the renewables giant "will emerge in an even stronger position once the tide turns."

"While damage has been done to investor confidence in [management], we think this can be restored over time through financial execution," they told clients Oct. 2. "We also think improved transparency would be helpful as the 'trust me' aspect of the [NextEra] story has taken a hit."

Renewables struggling

NEP is not the only renewables developer battling economic headwinds.

High interest rates are also hurting equity valuations for residential solar installers like Sunnova Energy International Inc. and Sunrun Inc., while solar inverter manufacturers Enphase Energy Inc. and SolarEdge Technologies Inc. face excess US inventory, Morgan Stanley wrote Oct. 3.

BofA Securities told clients Sept. 22 that it expects Eversource Energy, which recorded a $331.0 million after-tax impairment related to its offshore wind business for the second quarter, to delay announcing the sale of its 50% of the joint venture with Ørsted A/S until 2024 "given uncertainty on federal tax credits incentives and [the] New York request for higher [offshore wind renewable energy certificates] compensation."

Ørsted in August announced anticipated impairments worth up to $2.3 billion for its three northeastern US projects, two of which are co-owned with Eversource. Since then, the developer's shares have nose-dived nearly 40% to settle at 334.30 Danish kroner on Oct. 4, calling into question the company's risk management.

Still, analysts at Morgan Stanley in a separate Oct. 4 note called the renewables stock price slump "overdone" given that "the cost of a renewables project only rises by [approximately 5%] for every 1% increase in interest rates on our math, and this is not enough to cause a slowdown in industry growth levels."

Power purchase agreement prices are also increasing to compensate for higher interest rates and inflation, particularly for onshore wind, solar and storage, while some offshore wind developers have opted to cancel power supply contracts that are no longer economic.

Non-utility scale developers' balance sheets are also benefiting as "difficult execution has led to a broad shortage of projects," making finished projects "more valuable," BofA Securities analysts wrote Oct. 3.

Pre-construction projects, on the other hand, have been sidelined by clogged interconnection queues, limited availability of tax equity financing and higher debt expenses.

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