Want a hot stock tip on an up-and-comer? That would be utilities. You know, the stodgy electric companies that live in a tangle of state regulation and don’t deliver blow-out earnings growth.
But utilities, an extremely underappreciated sector, are the contrarian pick of T. Rowe Price, the giant asset manager. In a news briefing in New York on Tuesday, portfolio manager David Giroux made a fascinating case for why utilities will be the star of the future, involving renewable energy sources and their rapidly improving technology.
The standard view of utilities’ future is that they will gradually get rid of coal-fired plants in favor of natural gas, which is cheaper and cleaner-burning. Not much excitement there.
The market agrees. Among the 11 S&P 500 sectors, utilities rank as No. 9 in terms of total return thus far in 2019, according to Yardeni Research. Up to now, it has generated 18.5% year to date, which isn’t shabby, unless you compare it to others. The S&P 500 overall averages 24.5%. The biggest winner is information technology, at 40.9%. The only two worse than utilities are health care (12.1%), burdened with political pressures, and energy (2.5%), suffering from lower oil prices.
Utilities have long been treated as a bond substitute, owing to their relatively fat payouts. The sector’s 2.9% average dividend yield is the lushest among stocks, other than that of real estate, which has the same number. Only energy, artificially buoyed by its low denominator (i.e., its depressed stock prices), has a better yield, at 3.8%.
Utilities’ payout beats that of the benchmark 10-year Treasury note, at 1.78%. And like Treasury bonds, utilities are viewed as very safe—with the obvious exception of Pacific Gas & Electric, now mired in Chapter 11 because of claims against it for California’s deadly wildfires.
What investors miss, said T. Rowe’s Giroux, is that “the conventional wisdom about utilities is outdated.” It used to be that utilities depended upon building large plants, which enabled them to pump up power bills to cover the costs, if state regulators would let them. Unsurprisingly, new plants often suffered from huge cost overruns, which sparked the ire of the regulators. Utilities seldom increased their earnings.
But these days, Giroux argued, earnings are perking up. More important, renewable energy is getting better and cheaper, as technological advances come to solar panels and wind turbines. A lot of the current grid is growing old and needs to be replaced: Power plants generally have a 30-year lifespan, and many were built in the 1970s and 1980s. Giroux predicted that, in two decades, two-thirds of the nation’s power will come from renewables. Utilities “are no longer a rate play,” he said.