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US utilities still offer shelter in turbulent market, analysts say


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US utilities still offer shelter in turbulent market, analysts say

U.S. utilities still offer a safe haven for investors despite the turbulence in equity and bond markets driven by an oil price collapse and coronavirus fears, according to analysts that track the sector.

"We argue that valuations seem extremely reasonable if not attractive, with falling global bond yields materially more important than falling equity market valuations," Scotia Capital (USA) Inc. analyst Andrew Weisel wrote in a March 10 report. "Fundamentally, we believe that long-term growth stories should largely remain intact, aided by lower customer bills from falling commodity/interest expenses."

U.S. utility stocks plunged along with the broader sell-off on March 9 amid fears of a recession sparked by an oil price war between Saudi Arabia and Russia, along with mounting concerns over the global spread of the novel coronavirus.

The S&P 500 Utilities sector finished 5.64% lower on March 9 at 319.67, while the S&P 500 Energy sector ended the day down 20.08% at 254.65. The S&P 500 tumbled 7.60% to close at 2,746.56 and the Dow Jones Industrial Average fell 7.79% to 23,851.02, marking their worst single-day losses since 2008.

"Utilities are defensive and when markets have downturns they tend to outperform, which usually means they go down by less," Weisel said in a March 10 phone interview. "The tricky thing about these days is on any individual day that may or may not be the case. We have seen a lot of days where the markets swing 3%, 4%, 5% or more in either direction and on those days, it's really hard to say if utilities will move in the same direction ... or if they'll move in the opposite direction."

Stocks rallied on March 10 after President Donald Trump floated a financial relief package to offset the economic fallout from the coronavirus outbreak. U.S. utility stocks ended the day mixed.

NextEra Energy Inc. fell 2.12% to close at $255.73, while Dominion Energy Inc. closed up 2.32% at $83.22.

While CenterPoint Energy Inc. shares dropped 16.33% in heavy trading on March 9 at $18.03, the stock closed up 3.77% at $18.71 in more than double the average trading volume on March 10.

"We are now seeing a historically high valuation gap between utilities and BBB bonds, and believe US utility stocks screen very attractive given their strong dividend yields, low-risk growth ... and defensiveness in an environment marked by low growth and low interest rates," Morgan Stanley & Co. LLC analyst Stephen Byrd wrote in a March 10 report.

Morgan Stanley said its "top picks in this environment" are American Electric Power Co. Inc., which it upgraded to "overweight"; Ameren Corp.; and Exelon Corp.

AEP closed down in above-average trading at $94.72, while Ameren closed up nearly 2% at $82.59 and Exelon closed up 2.89% at $43.12.

"We believe the combination of the growth/decarbonization appeal with the defensive quality of a subset of our utility stocks will prove compelling through the near, medium, and long term," Morgan Stanley wrote.

Weisel noted that he is focused on the "smooth-out trend" for the sector.

"Meaning over the course of a week, a month or longer, the utilities should perform as low-beta defense stocks and that's true in both directions," the analyst said. "But again, on any given day, it's almost impossible to say how the group will perform relative to the markets when you see these gigantic swings in the macro sentiment."

Analysts are not yet seeing any long-term impacts to financial growth plans or earnings guidance for the utilities sector.

"The big picture growth outlooks probably haven't changed very much especially compared to other sectors that have had their worlds rocked," Weisel said, pointing to "some subtle changes" for U.S. utilities.

Lower gas and purchase power costs lead to better customer affordability and "headroom" to increase capital expenditure plans, while lower interest expenses also help customers and parent holding companies, the analyst said.

On the flip side, there is a risk of lower industrial and commercial demand with a "small risk" of lower allowed ROEs.

"Overall, I think the utility outlook is marginally better than it was a month ago thanks to the lower customers bills helping affordability," Weisel said. "But by and large, I wouldn't expect dramatic revisions to earnings guidance, for example."

Equity plans also are seen as unlikely to change for the moment, but a delay in the timing of issuances is possible.

With the oil price war hiking the potential for consolidation amid U.S. oil and gas producers, the sentiment is not the same for utilities.

"Whenever stocks fall this sharply over a short period of time, M&A always comes up as a possibility," Weisel said. "I still think it's pretty unlikely. My view is that there's not a lot of good takeout candidates out there these days given how big these utilities have become. Could there be an example of a really beaten down stock getting acquired? Absolutely. I think there are certain companies that have a wish list that they're ready to jump on but I'd say it's still unlikely to happen in the near term."