Rate Worries Restore Utility Sector Values

It’s been roughly seven months since the Dow Jones Utility Average last made a new high. Since then, it’s underperformed the S&P 500 by nearly 21 percentage points.

Most blame fear of rising interest rates. I fault the manic expectations that pushed prices to unsustainable heights last year. But whatever the catalysts, sector valuations are returning to earth.

What’s remarkable is this is happening despite extremely healthy industry earnings, demonstrated by robust first quarter results. Equally encouraging, regulatory treatment of corporate tax cut savings has so far supported utility balance sheets, as well as rate base and earnings growth, removing a key concern of credit raters.

As the Endangered Dividends List shows, not every essential services company is prospering. But high quality companies that have retreated to good entry points increasingly outnumber the stragglers.

So far this year, we’ve added Comcast Corp (NSDQ: CMCSA) and Edison International (NYSE: EIX) to the Portfolios at their lowest prices since 2016. This month, we’re picking up Sempra Energy (NYSE: SRE). The other Focus stock is Kinder Morgan Inc (NYSE: KMI), which pulled off a major coup in late May by selling its controversial Trans Mountain pipeline to the Canadian government.

Not surprisingly, lower valuations have revived utility sector mergers and acquisitions. My feature article highlights three ways to bet: Arbitrage plays on deals already announced but not yet closed, buying stocks of likely takeover targets and picking up high yield bonds of merger candidates that have much to gain by being acquired.