Gas utility stocks extend rally in Q1 2024, buoyed by Southwest Gas surge

A basket of gas utility stocks eked out a second consecutive quarter of gains in the first three months of 2024, barely shrugging off resurgent bond yields that pummeled the subsector in 2023.

The positive outcome for the industry was due in no small part to a blockbuster quarter for Southwest Gas Holdings Inc., which has rallied sharply as the company executes a turnaround effort backed by activist investor Carl Icahn.

An index of eight gas utility stocks selected by S&P Global Commodity Insights gained 2.7% in the first quarter of 2024. The performance extended the group's fourth-quarter 2023 rally.

Early in the quarter, gas utility stocks came under renewed pressure as US 10-year Treasury yields rebounded on strong economic data and stubborn inflation readings, market watchers told Commodity Insights. That caused the market to pare back expectations for interest rate cuts by the US Federal Reserve.

"As such, utilities stocks were squeezed from both sides: Rising yields putting a lid on share prices and a better macroeconomic backdrop shunning the sector's defensive nature," Nasdaq IR senior analyst Massud Ghaussy said.

Market still tipped against gas utilities

Some of that pressure may have eased in March, as the Atlanta Fed's GDPNow model suggested that US economic activity had cooled off in the first quarter, according to Jay Rhame, CEO of Reaves Asset Management and co-portfolio manager of the Virtus Reaves Utilities ETF.

A handful of tech stocks with exposure to artificial intelligence continued to attract capital at the expense of some utility names, Rhame said.

So far, that trade has disproportionately benefitted independent power producers and regulated electric utilities poised to meet the power demand that AI will place on datacenters, the market watchers said.

The S&P 500 Utility sector gained 3.6% in the first quarter, while the S&P 500 surged 10.2%.

Southwest Gas bolsters group

Yet one constituent of the gas utility basket topped both indexes. Shares of Southwest Gas rocketed 20.2% higher during the first quarter, far surpassing low single-digit stock price gains for Atmos Energy Corp., Chesapeake Utilities Corp. and One Gas Inc.

The stock price surge came on the heels of bullish 2024 guidance and improved return on equity in 2023 at Southwest Gas. In addition to the positive outlook and earnings results, company commentary appeared to raise optimism around Arizona utility regulation, Rhame said.

The company's Arizona rate case filing included a request for a capital tracker that would allow the company to recover certain safety investments annually, minimizing regulatory lag and possibly reducing its pace of general rate case filings, Southwest Gas Corp. President Justin Brown told investors during a Feb. 28 conference call.

The Arizona regulatory environment has historically produced substantial regulatory lag, or the difference between when a utility invests capital and recoups it from ratepayers, Rhame noted. But the Arizona Corporation Commission (ACC) has recently approved similar mechanisms to reduce lag for electric utilities Arizona Public Service Co. and UNS Electric Inc., raising the market's hopes that Southwest Gas will be successful, Rhame said.

It is unclear if the ACC will extend a similar mechanism to a gas utility, said Jim Davis, an analyst at Regulatory Research Associates, a group within Commodity Insights. Electric utilities have different capital expenditure profiles than local gas distribution companies, Davis noted.

Waiting for a catalyst

Regulatory lag in other areas has presented a challenge to gas utilities amid persistent inflation and high interest rates, which can require increased rate case activity.

– Access more details on energy and utility news. – Explore the ownership history for gas utilities. – Dig into Financial Focus research.

Northwest Natural Holding Co. recently warned investors that full-year earnings would contract in 2024 as heightened safety and reliability spending and information technology investments lead to regulatory lag. Northwest Natural was one of the utilities in the select group that had quarterly stock price declines, a category that also included UGI Corp., Spire Inc. and New Jersey Resources Corp.

Gas utilities now have attractive valuations following long-term underperformance, but investors might remain on the sidelines until companies work through big rate cases and the Fed begins cutting interest rates, Rhame said.

"You have a pretty good path to high single-digit, low double-digit returns from here," he said. "It's just that you don't quite have the catalyst for the big rush into the sector."