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Investment Strategy

10 Trends for Essential-Service Stocks in 2017

By Roger S. Conrad on Dec. 20, 2016

As the year ends a new one begins, we outline the trends and picks likely to drive profits. These ten trends for essential-service stocks are taken from an in-depth piece in the December 2016 issue of Conrad’s Utility Investor. If you’re a subscriber, head over to CUI, login, and read the full article for additional analysis and specific picks that accompany each trend. If you aren’t a subscriber, do so now.

Looking Back Before Moving Forward

The December 2015 issue of CUI emphasized the importance of diversification to generating differentiated returns in 2016. In an aging bull market where fewer stocks lead the charge higher, selection becomes more critical. Along with our outlook for the eight major industries in the CUI coverage universe, we highlighted a pick and a pan from each.

Despite a few laggards, these picks have outperformed, generating an average total return of 18.6 percent. Year to date, the Dow Jones Utility Average has gained 15 percent. Three of our eight pans are deep in the red, resulting in an average total return of less than 2 percent.

This year, we’ve opted to highlight 10 trends that should drive outperformance for investors who play them the right way.

Trend No. 1: Correction in Utility Stocks Continues

The pullback in the Dow Jones Utility Average that began in early July 2016 will continue, taking one step forward and two steps backward. This correction could lead to the sector bottoming in the second half of 2017.

Every bull market eventually comes to an end, triggered by catalysts that often emerge only in the midst of the pullback or in hindsight. But the expectations baked into current valuations have outstripped the group’s growth prospects, suggesting that the momentum-seeking investors who have piled into utility stocks will take advantage of an excuse to take profits.

Subscribe to CUI to read Roger’s analysis in full and find out which stocks are primed to profit from this trend.

Trend No. 2: Utilities Continue Investment Trends

President-elect Donald Trump’s nomination of Oklahoma Attorney General Scott Pruitt to head the Environmental Protection Agency (EPA) suggests that the Obama administration’s Clean Power Plan may not be long for this world.

Oddly enough, rubbishing the Clean Power Plan and ending tax credits for wind and solar power could accelerate these trends by driving non-utility competitors out of the business. In this scenario, utilities would also have more flexibility to extract maximum economic value from their newer coal plants.

Trend No. 3 Oil and Gas Prices Remain Range Bound

A severely cold winter can catalyze a temporary surge in natural gas prices, while political upheaval or security-related disruptions in a major oil-producing country would cause a spike in oil prices.

But our base case calls for oil prices to range between $40 and $60 per barrel and natural gas to remain below $4 per million British thermal units.

Subscribe to CUI to access Roger’s Utility Report Card, a comprehensive breakdown of the utility and essential-service stock universe.

Trend No. 4: Currency Headwinds Abate for Canadian and Australian Stocks

The CUI Aggressive and Conservative model Portfolios include several Canadian and Australian stocks, many of which have been under pressure from weakness in their home currencies over the past few years. This headwind made it difficult for US investors to generate a profit from international stocks.

But both the Canadian and Australian dollars have stabilized and look set to finish the year slightly higher relative to Uncle Buck.

Trend No. 5: Major Telecom Merger

The Obama administration’s commitment to keeping the number of national wireless telecom providers at four could fall by the wayside during Trump’s presidency.

Subscribe to CUI to read the full article, along with Roger’s favorite telecom stocks.

Trend No. 6: Pipeline Delays Continue at State Level

Despite an incoming administration that’s eager to support the construction of oil and gas pipelines, state and local opposition will continue to result in delays and court battles for high-profile infrastructure projects.

This trend will result in better returns for companies that own existing infrastructure.

Trend No. 7: Utilities Continue to Leverage Superior Cost of Capital

Regulated utilities will continue to take advantage of their superior cost of capital to buy into complementary pipeline assets and invest in renewable energy.

A growing supply of green bonds issued by electric utilities, coupled with defaults by pure-play solar-power companies, could make buyers more sensitive to credit risk. These dynamics would widen electric utilities’ advantages in the debt market.

Subscribe to CUI to access all five model portfolios and scorecards, which include Roger’s favorite bond picks.

Trend No. 8: Mexico, Land of Opportunity

Mexico’s growing appetite for cheap natural gas produced in the US will create opportunities for midstream operators on both sides of the border.

Exports of US natural gas to Mexico exceeded the volumes piped to Canada for the first time in 2015, reflecting a 44 percent upsurge in shipments south of the border. This trend has continued in 2016, with US pipeline exports of natural gas growing by 32 percent year over year.

All signs point to US exports of natural gas to Mexico growing significantly in coming years.

Trend No. 9: Cost Cutting and Efficiency Gains to Drive Investment and Earnings Growth

Utilities’ earnings power has started to decouple from sales volumes, as rate structures reward companies for capital expenditures that improve operational efficiency and help to reduce overall demand. Grid investments can also boost earnings if these improvements cut operating costs.

Subscribe to CUI to read about how companies are cutting costs and which ones are doing it right.

Trend No. 10: Corporate Tax Cuts and Infrastructure Spending

Utilities’ investments in land and hefty capital expenditures enable these companies to save money on taxes by writing down noncash expenses. But utilities would still benefit from a reduction in corporate taxes, especially ones that encourage infrastructure spending.

 

MODEL PORTFOLIOS & RATINGS

ABOUT ROGER CONRAD

Roger S. Conrad needs no introduction to individual and professional investors, many of whom have profited from his decades of experience uncovering the best dividend-paying stocks for accumulating sustainable wealth. Roger b