16 BARRON’S August 5, 2019
Utility stocks have gotten expensive as investors seek
shelter, but value still exists. By Lawrence C. Strauss
streams,” says Edemeka.
EdemekaestimatesthatDominioncanboostits
percentageofearningsfromregulatedutilityoper-
ationsandcontractsforgasinfrastructureto95%
in 2022, up from 85% in 2017.
Thestock,at$76andtradingaround17timesnext
year’s consensus profit estimate, is cheaper than
someofitspeersandbelowitsfive-yearaverageof
18.2times,accordingtoFactSet.Ityields4.8%.
A question mark is Dominion’s attempt, along
with two other utilities, to complete the 600-mile
AtlanticCoastPipelinethroughWestVirginia,Vir-
ginia,andNorthCarolina.Thenatural-gaspipeline
facesenvironmentalconcernsandlegalchallenges,
amongotherhurdles.Theproject’sdevelopersare
askingtheSupremeCourttoreinstatepermitsto
allow it to traverse the Appalachian Trail.
“Iftheyacquirethenecessarypermitsandfinish
the pipeline, that should be an earnings and cash-
flowstreamthatisverypredictable,”Edemekasays.
Another of his holdings is Exelon (EXC), a
Chicago-basedcompanythatgenerates,transmits,
anddistributespowerinvariousmarkets.Besides
Chicago,itsserviceareasincludeBaltimore,Phila-
delphia, and Delaware. About half of its revenue
comes from regulated businesses.
The company’s stock, trading around $44, is
cheaperthanmanyofitspeers’.Itfetchesalittle
less than 15 times the $3.07 a share it’s expected
toearnnextyear,belowtheaverageof18.4times
for large utility stocks in the S&P 500 index.
Exelon, Edemeka says, “over the past several
years has significantly grown its regulated earn-
ings base,” partly through acquisitions, and has
made“significantorganicinvestmentinitsdistri-
butionnetwork.”Havingahigherratebase,which
for a utility is the value of the property on which
it can earn a return, helps revenue and profit
growth. “Strong capital spending will likely con-
tinue to help utilities drive base-rate growth for
thenextfewyears,”saysChristopherMuir,autili-
ties analyst at CFRA Research.
The Fed may have helped onthisfrontwithits
quarter-point rate cut this past week. This could
translate into lower borrowing costs for utilities,
which tend to carry big debt loads.
Edemeka expects Exelon’s regulated utility
profitstogrow6%to8%ayearandtoaccountfor
more than 70% of its earnings per share by 2022,
upfrom55%in2018.Hebelievesthatthecompany
cannarrowthevaluationgaptoitspeersasitsreg-
ulated business grows. Exelon is the largest U.S.
operatorofnuclearplants,asegmentofthepower
industry that carries high overhead and safety
risksforoperators.ButExelonisbeinghelpedin
somestatesbyzero-emissioncreditsthatarehelp-
ing to stabilize revenues from the nuclear assets.
“The market has not yet given full credit for
thederiskingoftheiroverallbusiness,”saysEde-
meka.Ifthatdoesoccur,thestockcouldappreciate
atleast15%,andadividendyieldof3.3%isanice
sweetener in the meantime.
“The
investing
backdrop
for utilities
remains
attractive,
but with higher
valuations
it does pay
to be more
selective.”
Bobby Edemeka,
PGIM Jennison
Utility fund
Utility Players
Utility stocks have gotten pricey, but some look attractive.
1-Year
Recent Total 2020 E Div Market
Company / Ticker Price Return P/E Yield Value (bil)Dominion Energy / D $75.91 13.1% 17.2 4.8% $61.
Exelon / EXC 44.40 9.0 14.5 3.3 43.
Utilities Select Sector SPDR / XLU 60.16 18.5 18.4 3.1 10.1*
*Total Net Assets. E=Estimate. Sources: FactSet; Bloomberg
How to Play
Effective Defense
I
NVESTORS TOOK SHELTER IN UTILITY STOCKS
during the past few days of market declines,
underscoring the sector’s time-honored role as
a haven during times of duress.
The Utilities Select Sector SPDR fund (ticker:
XLU)gained1%onThursdayandwasflatonFri-
day, outpacing broader market indexes that fell
sharply amid a flare-up in trade tensions and the
FederalReserve’sfirstinterest-ratecutsince2008.
The outperformance of defensive sectors such
asutilitiesfollowingaratecut,saysWayneWicker,
chief investment officer of Vantagepoint Invest-
mentAdvisers,probablyreflectsaflighttostocks
that benefit from lower rates while investors as-
sess the state of global growth.
But utilities have gotten more expensive in
recent months, amid signs of a global slowdown
andintensifyinggeopoliticaltensions.Theutilities
SPDR, a good proxy for large U.S. utility stocks,
tradesat18.8timesitsexpectedearningsoverthe
next 12 months. That’s well above its five-year
average of about 17 times, according to FactSet.
Still,Wickerthinksthatlower-volatilitysectors
suchasutilitiesandotherhigher-yieldingsecuri-
tiesshouldcontinuetoworkwellthissummer,de-
spiteloftyvaluations.BobbyEdemeka,portfolioco-
managerofthe$3.3billion PGIM Jennison Utility
fund(PRUAX),concurs:“Theinvestingbackdrop
for utilities remains attractive, but with higher
valuations it does pay to be more selective.”
Where to turn?
Stephen Byrd, aMorganStanleyutilitiesanalyst,
thinks that the dividends of regulated utilities are
attractive, compared with BAA-rated corporate
bonds, whose yields were recently about 1.6 per-
centagepointsabovethoseofregulatedutilities,on
average. That yield spread is about a full point
lowerthantheaverageof2.5pointsdatingto1985.
Throwinreliableearningsgrowtharound5%,
or a little higher in some cases, he says, and it’s
notabadplacetoplaydefense—thehighervalua-
tions notwithstanding.
Edemekafavorselectricutilities,especiallythose
inregulatedbusinesses—forinstance,apowercom-
pany whose rates are approved by a regulatory
entity.Oneofhisholdingsis Dominion Energy (D),
whose operations include the regulated utility
Virginia Power, as well as unregulated units.
Thecompanyincreaseditsregulatedutilityearn-
ings,inpart,bymergingwithScana,whoseassets
includeSouthCarolinaElectric&Gas,inJanuary.
Michal Bednarski“Theyhaverefocusedonmore-predictableearnings