Will Utility Stocks Become "Less Boring" In the Future?
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- Oct 30, 2020 8:57 pm GMTOct 30, 2020 5:38 pm GMT
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With less than a week to go before America decides its next president, the stock market is shifting gears. Corporate developments have become less important in determining price swings than the policy positions staked out by the two main parties. For investors in utility stocks, these proposals are especially important because they will determine the industry’s future course at a pivotal time. The key question for them is how these elections will affect future stock prices for the sector.
A Less Boring Sector?
The Wall Street Journal recently published a piece about utility stocks claiming that they would become a “little less boring” in the coming years. “The global focus on climate change is shaking up the industry and the presidential election could shake it up even more,” the publication writes and questions whether investors will be willing to stick with utilities as they continue to go through “wrenching changes”. The changes referred to here are the impending shifts in business models for utilities in a decentralized grid powered by renewable energy. In turn, a shift in business operations could have profound implications for the priorities of utility stocks, from being an instrument for dividends to aggressively seeking out profits.
For investors, utility stocks are generally defensive plays that generate a steady stream of income for investors. The percentage dividends offered by the stocks is better than that offered by government securities and, in certain cases, be more frequent.
However, in a year when most certainties have turned topsy-turvy, utility stocks have lagged the overall performance of the S&P 500 index. Before the general economic turmoil caused by the pandemic, several utilities had publicly declared their intentions to eliminate fossil fuels from their energy mix and decarbonize operations. But the pandemic has saddled them with a pile of unpaid electric bills to add to their growing debt from issuing bonds.
To make the transition to becoming a “less boring” sector, utilities will need the assist of policy proposals that help them pad their bottom line with new sources of revenue. The incoming administration’s policies could have an important impact on their balance sheet and, in turn, their valuations. During a time of static or decreasing demand from residential customers, electrification of transportation and buildings offers a possible profit center. Rob Gramlich from Grid Strategies LLC estimates that it could result in a fifty percent increase in demand for electricity. But reaching that figure is possible only with sufficient innovation and investment and a reworking of transmission frameworks.
Democrat nominee Joe Biden, who seems to be ahead in most polls, plans to invest $2 trillion over the next four years towards climate change. He has set an ambitious timeline for decarbonizing the electric grid by 2035. That target stands in contrast to the more measured approach of utilities targeting a complete shift away from carbon by 2050. Most commentators have said it is unrealistic. For example, U.S. Energy Secretary Ernest Moniz says reaching the goal is possible only if this decade is a “supercharged innovation decade”.
Still, a Biden presidency will bring good tidings for utility stocks. He has proposed an extension of tax credits for developers of renewable energy sources. That should boost their production and, more importantly, make them cost-competitive with fossil fuel sources to enable utilities to reach their renewable energy targets. According to the latest EIA numbers, natural gas remains the dominant source for generating electricity. Biden’s double-speak on the fuel – he intends to phase out fracking “over time” but still wants to decarbonize the grid in 15 years – will ensure that natural gas has a role to play even as renewable energy ramps up in the grid. For publicly-listed utilities, such as Duke Energy, that depend on fossil fuels for a bulk of their electricity generation, Biden’s statements are good news because it buys them time to make the shift to renewable energy sources.
More of The Same
Wall Street is pleased with the Biden-Harris energy plan and the possibility of future growth. The WSJ piece quotes Rob Thummel, senior portfolio manager at Tortoise Capital, as saying that there’s more “potential for growth than there has been.” In recent times, the Street has become enamored with future growth potential. Witness the surge in technology stock valuations during the pandemic. But utility stocks may not witness a similar influx of funds because of regulatory restrictions and the impossibility of implementing sudden pivots to their business models. But their balance sheet remains solid, a testament to conservative cash management and restricted revenue growth, and their stock prices trade at a discount to the overall valuation. And, despite being kneecapped by the pandemic shutdown, utilities have kept their dividend commitments. The chances that this state of affairs will spiral into aggrssive growth after the economy reopens remains dim. In other words, despite Biden’s aggressive timelines, it might be some time before utility stocks become “less boring”.