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Utility Stocks

Conference Reflections

By Roger S. Conrad on Nov. 16, 2015

In 2014, US electric utilities spent $103 billion on system upgrades and expansions; this year, the industry is on track for $110 billion in capital expenditures. Guidance and announced projects suggest a similar level of investment in 2016.

Last week, I attended the Edison Electric Institute’s 50th Annual Financial Conference, a must-attend event for industry insiders and analysts who cover the space. This three-day conference gives investors an invaluable opportunity to identify emerging trends and opportunities—specifically, the focal points of the industry’s robust capital expenditures.

Here’s a quick rundown of my main takeaways from the conference, based on my almost 30 years of covering utility stocks and an intense few weeks wading through earnings reports and calls for the more than 200 essential-service companies in our Utility Report Card.

Takeaway No. 1: No Wait, No Problem

This year’s conference involved a lot less waiting around than other conferences we’ve attended. Attendees had ample opportunity to pepper top executives with questions—and I took full advantage. There wasn’t even a line for coffee, my preferred energy source at these events.

In contrast, the National Association of Publicly Traded Partnerships’ MLP investor conference, which we attended and covered in Energy & Income Advisor, featured jam-packed presentations and breakout sessions–a testament to master limited partnerships’ popularity (MLP) in May 2015.

Resilient business models, high yields and solid growth prospects aside, electric utilities evidently don’t elicit the same degree of enthusiasm among income-seeking investors.

The billionaires’ investing secret to buy what’s out of favor and sell when anything becomes too popular. Although a well-attended industry conference doesn’t necessarily signal a peak, the rapid expansion of the National Association of Publicly Traded Partnerships’ annual MLP investor conference, which in recent years had relocated from the Northeast to Florida, reflected the amount of speculative capital flowing into the space.

The sparse crowd at the Edison Electric Institute’s conference hardly guarantees big profits for utilities and their shareholders over the next six months. But solid third-quarter results and valuations that remain slightly below the sector’s long-term average suggest there are opportunities to be had.

Fixed-income investors easily outnumbered equity-focused analysts and portfolio managers in attendance—another sign that the utility sector remains as sleepy as ever.

Takeaway No. 2: Solar Power

Not surprisingly, CEOs and other executives from electric utilities repeatedly argued that their companies were ahead of the curve on disruptive technologies such as solar power and energy storage.

But Tom Werner, CEO of solar-power developer SunPower Corp (NSDQ: SPWR), also dismissed the “noise and rhetoric” on “popular blog sites” and called idea that utilities are slow-moving dinosaurs destined for extinction “a myth.” Werner emphasized that the industry remains on “the leading edge” of a push for cost-effective, cleaner and more reliable electricity.

Werner’s comments reflect SunPower’s increasing cooperation with incumbent electric utilities. At the conference, the company unveiled a new business segment that will combine rooftop solar power, energy storage and management systems to sell electricity in the California market.

This plan dovetails with PG&E Corp (NYSE: PCG), Sempra Energy (NYSE: SRE) and Edison International’s (NYSE: EIX) heavy investments in their power grids to accommodate this generation capacity.

SunPower’s guidance for solid earnings growth contrasts sharply with so-called utility killer SolarCity Corp (NSDQ: SCTY), a ticking time bomb that historically has generated more hype than profit. (See Solar Power: Not a Death Knell for Utilities.) We maintain our long-standing Sell rating on SolarCity Corp.

Takeaway No. 3: Low-Risk Growth, Interest Rates Be Damned

The Edison Electric Institute’s members remain on course for almost $110 billion in capital expenditures this year—much higher than the estimate of $95.8 billion issued at last year’s financial conference.

About 32 percent of this spending will go toward new generation capacity, primarily wind power and gas-fired plants. Another 56 percent is slated for transmission and distribution systems to accommodate this new generation.

From a bond investor’s perspective, those outlays present risks to credit. But for stockholders, these expenditures provide fuel for consistent earnings and dividend growth in coming years. Relationships between utilities and regulators remain salutary in most states, ensuring a reasonable return on investment.

Utilities also continue to enjoy ready access to low-cost debt capital, though the Federal Reserve’s commitment to normalizing monetary policy will result in higher borrowing costs over time.

However, investors should also bear in mind that the Dow Jones Utilities Average returned more than 60 percent from June 2004 to June 2006, when the Fed hiked interest rates by 425 basis points. Utility stocks underperformed in the months leading up to this tightening cycle, but were off to the races once the central bank finally made its first move.

That so many investors fear rising interest rates attests to the so-called end of history in a 24-hour news cycle that privileges sensationalism over perspective. Nevertheless, these fears, coupled with technical indicators that suggest a growing risk of a bear market, could create an ideal opportunity for savvy investors to establish or add to positions in high-quality utility stocks that boast the best growth prospects.

For now, borrowing rates remain quite low, increasing the odds of regulators approving a fair return on capital. For example days after the conference, Southern Company’s (NYSE: SO) unregulated Southern Power unit upsized an offering of green bonds to $1 billion as part of an effort to fund its investments in solar power.

Bottom Line: Regulated electric utilities enjoy much lower costs of capital than solar-power developers and formerly high-flying companies developing pipelines and processing plants to handle America’s surging natural-gas production—a huge competitive advantage for those expanding in these areas.

Subscribe to Conrad’s Utility Investor today for instant access to my exclusive video report on my best investment ideas from the Edison Electric Institute’s 50th annual financial conference.

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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