So long as the Federal Reserve is on the warpath against inflation, risk of recession will be elevated. And that tilts the odds heavily in favor of lower stock prices over the next few months.
The utility stock rally we’ve seen since the October issue of CUI posted, however, is proof positive that the trends powering sector outperformance this year are entrenched as ever. That’s ongoing re-shoring of investment and manufacturing to the US, investors’ preference for domestic business, low relative valuations, recession resilience and unprecedented federal tax credits from the Inflation Reduction Act to help finance grid upgrades and renewable energy deployment.
The most recent upside catalyst for utility stocks: Q3 earnings and guidance updates that highlight undimmed resilience despite pressure from inflation, the skyrocketing cost of debt capital and recession risk.
Deciphering results and statements by management is rarely a straightforward process. The automatically generated articles in the investment media almost always focus on the wrong numbers. So do many popular screening services used by investors to sort companies.
Most absurd is the game Wall Street analysts play with so-called earnings “estimates.” These routinely trigger stampedes into and out of stocks, which are many times fully reversed once it becomes clear the “misses” or “beats” were irrelevant to a company’s health, value or dividend safety.
Earnings results are absolutely critical in one respect: They’re the clearest window into the general health of companies, which is never more critical to accurately judge than in a dangerous economic environment like this one.
It’s not whether a company measures up on some number in Q3, be it revenue, earnings or cash flow. Rather, it’s how inflation pressure affected sales and costs. It’s whether or now management was able to secure financing at affordable rates, despite a spiking cost of debt capital even for the strongest companies. And it’s how well results are tracking management’s guidance needed to produce target earnings and dividend growth, which stocks are valued on.
This year, the Dow Jones Utility Average (DJUA) was well in the black until mid-September. Then just short of making a new all-time high, the DJUA plunged by nearly 23 percent.
The sector simply caught up in the stock market’s “sell everything moment” in the wake of a 75 basis point Fed Funds rate increase. That proved once again that nothing fully resists a severe selloff. But equally, so long as companies stay solid on the inside, their stocks will always eventually recover losses sustained in an overall market slide.
That’s what makes the solid utility sector Q3 results we’ve seen to date both meaningful and encouraging. I’ll have a full wrap up of how Utility Report Card companies fared in the November issue of CUI, with a special focus on Portfolio recommendations. But here are a few takeaways from what’s been reported so far.
First, even companies that appeared to face potential challenges in Q3 have reaffirmed full-year guidance. Avangrid Inc (AGR) and its 81.65 percent owner Iberdrola SA (IBE, IBDRY), for example, are the most aggressive developers of offshore wind projects on the US Atlantic Coast. And there’s considerable concern about whether the cost of projects has already risen well above their initial estimates, as they typically take 4 to 5 years to site, permit, finance and build.
Avangrid is now renegotiating with regulators for a higher rate at its Park City and Commonwealth projects, on the basis it’s needed to meet higher costs. But while the outcome is highly uncertain, the company also this week reaffirmed the mid-point of its adjusted earnings guidance range for 2022 at $2.29 per share, and more importantly its target 6 to 7 percent annual earnings growth target through 2025.
One reason for that confidence is CAPEX at its regulated utilities (80 percent of earnings) continues to go smoothly. There are amicable rate deals in hand for New York and on track in Massachusetts for this year. The proposed merger with PNM Resources (PNM) still appears to be on track to close in early 2023, providing another big boost and arena to invest. And on the unregulated side, the 800-megawatt capacity Vineyard Wind facility is on track for full production in 2024 with costs locked in.
NextEra Energy (NEE) is the utility that was in the eye of Hurricane Ian. But the utility posted 13 percent Q3 earnings growth, led by an 11.3 percent increase in regulatory capital employed and 19.4 percent higher profit at the unregulated Energy Resources unit. And management again affirmed earnings guidance through 2025.
NextEra’s results should also lay to rest any concern regulatory pushback is slowing its deployment of wind, solar and battery storage. The company added 2,345 megawatts of new renewables and storage origination in Q3, boosting backlog north of 20 gigawatts.
All of these projects that can be sited, permitted, financed and built in less than 2 years. And they’re funded at low cost with a combination of institutional partners, utility customers and low-cost green bonds. That locks in costs once power sales agreements are signed. And it’s a formula that continues to fuel reliable annual dividend growth north of 10 percent for both NextEra and its NextEra Energy Partners (NEP) affiliate.
Southern Company (SO) now sees 2022 earnings “near the top end” of its $3.50 to $3.60 per share guidance range. The utility also reduced by $70 million the projected remaining cost of bringing its two Vogtle nuclear reactors into service by the end of 2023, completing installation of fuel rods at Unit 3 and 97 percent of work at Unit 4.
Southern also reported a 2.2 percent lift in Q3 industrial sales, along with 1.1 percent growth in electricity customers. That’s a pretty good sign the company’s southeastern US service territory is also proving resilient.
Bottom line: These utilities have again affirmed underlying businesses are healthy and meeting long-term earnings and dividend growth guidance. That’s my primary criteria for sticking with them, and it bodes well for the rest of the portfolio as well.