Roger S. Conrad

The Dow Jones Utility Average closed out Q1 barely in the black and lagging the S&P 500 by about 9.3 percentage points. The average total return for CUI portfolio stocks was a bit better at 5.8 percent. But the bottom line is this is still a stock market chasing momentum and growth stories, rather than value and dividends. The essential services stocks that have shone the most so far in 2024 have been tightly connected to popular investment themes like nuclear power, such as our top performer Vistra Energy (NYSE: VST), or else beneficiaries of M&A. MDU Resources’ (NYSE: MDU) pending spinoff of Everus Construction Group in late 2024, for example, is exciting investors as much as last year’s of materials company Knife River (NYSE: KNF) did not—mainly because KNF has roughly doubled in value since.

Earlier this year, what promised to be an Atlantic Coast offshore wind boom seemed to go bust. Lead developer Orsted A/S (Denmark: ORSTED, OTC: DNNGY) ousted upper management and wrote off $6 billion in shelved US projects, citing development cost spikes and uneconomic contracts. And its 50 percent partner EverSource Energy’s (NYSE: ES) felt its pain, taking a $5.58 per share impairment charge against Q4 earnings. EverSource’s plan all along has been to sell its ownership of the offshore projects to focus on linking transmission infrastructure. The writedown reflected the diminished value of those assets. But it now appears the demise of US offshore wind was indeed greatly exaggerated.

To pivot or not to pivot—That’s the question the Federal Reserve continues to ponder in spring of 2024. Every stray data point on inflation seems to heighten the sense of inertia. And with benchmark interest rates indeed staying higher for longer, investors’ fear of debt and general disinterest in dividends persists. But there are signs sentiment is at last starting to shift. Changing allocations and a highly volatile quarterly payout makes the iShares Select Dividend ETF (NYSE: DVY) a poor proxy or substitute for a well-chosen portfolio of dividend stocks. But the ETF does follow the Dow Jones Select Dividend Index of 99 high yielding stocks and has definitively resumed the uptrend it began in late October.

In this month’s Utility Report Card, I highlight how companies stack up on each of our Quality Grade criteria. One big takeaway on balance sheet risk: Higher for longer interest rates are a much-diminished risk to dividends. Companies are still paying more to refinance debt. But long-term borrowing costs are actually lower than where they began 2023 for most companies. And the result is the wave of debt offerings highlighted in URC comments, particularly of 10 years maturity and greater.

Electricity and fiber broadband: They’re critical elements for the exploding number of “hyper-scale” US data centers, which in turn are vital for the proliferation of artificial intelligence applications. At the nexus of both power and fiber are two sectors that to date have been largely ignored by many investors: Electricity and Communications utilities.

So far in 2024, the Dow Jones Utility Average lags the S&P 500 by nearly 10 percentage points. But over the past month, buying interest has picked up for at least a handful of CUI portfolio companies. Leading the way are nuclear powered Constellation Energy (NYSE: CEG) and Vistra Energy (NYSE: VST), with year-to-date gains of 46 and 57 percent respectively. But even underperforming Avangrid Inc (NYSE: AGR) now has a double-digit 2024 return, as parent Iberdrola SA (Spain: IBE, OTC: IBDRY) has made a non-binding all-cash takeover offer that’s likely to go higher. I continue to believe utilities as a sector won’t really capture upside momentum until there’s a genuine Federal Reserve pivot to lower interest rates. And with the central bank reactive as ever to the latest data point, investors have no choice but to be patient.

Conservative Holding Sempra Energy (NYSE: SRE) last month raised its five-year capital-spending plan by 20 percent to $48 billion. One big reason we can be confident management will turn that into robust earnings growth: 90 percent is targeted for already regulator-approved utility system investment in California and Texas. The rest will finance a portfolio of high return, pre-contracted LNG and renewable energy projects in the southwest US and Mexico. California’s drive to simultaneously electrify everything and stanch the danger of wildfires is spurring an earnings-lifting CAPEX bonanza for its utilities. That includes natural gas, as the realization energy transitions take time convinced regulators to authorize a 50 percent capacity boost at Sempra’s Aliso Canyon storage facility—which some wanted to close not long ago. And state law linking utility returns to interest rates has seen returns on equity surge to over 10 percent this year.

It’s fair to say that Algonquin Power & Utilities (TSX: AQN, NYSE: AQN) has been a problematic recommendation the past few years. Aggressive expansion boosted profits for years, then suddenly hit a brick wall of rising borrowing costs. And Kentucky regulators broke up the acquisition of American Electric Power’s (NYSE: AEP) operations in that state. But after boosting Q4 earnings and EBITDA by 14 and 13 percent, respectively, Algonquin’s core business is strengthening again. And the long awaited sale of non-utility assets may happen as soon as mid-year—lifting the long-lagging share price with massive debt reduction and stock buybacks. Operating profit at Algonquin’s regulated utilities in 2023 increased by 10.5 percent, thanks largely to rate increases paying for system investments. That will be the major driver of growth in 2024 and beyond, along with systematic cost management. During the earnings call, management highlighted $105.8 million pending rate increase requests to be decided this year.

Last month, I highlighted three key takeaways, drawn from the Q4 results and guidance updates of Utility Report Card members I’d seen so far. They were: Number one, results and guidance demonstrated very healthy and growing business. Recommended companies met my chief criterion for continuing to own them, as well as add to current positions when appropriate. Second, every company affirmed its guidance for earnings growth as well as capital spending plans fueling it. And more than a few actually raised long-term investment targets.