The market continues to have a rough 2022. After a relief rally Wednesday following the Fed’s rate hike decision, stocks have once again turned sharply lower. It seems increasingly clear that growth-oriented sectors such as technology and consumer discretionary products will struggle until the inflation problem is tamed. And that could take awhile.
With that being the case, investors are understandably turning to defensive sectors such as consumer staples, REITs, energy, and utilities for protection.
Over the past six months, technology, as measured by the Invesco QQQ ETF (QQQ) has fallen more than 20%. Meanwhile energy is up dramatically and staples, real estate, and utilities have all largely held their ground. Over the past few weeks, however, even the defensive sectors have started to fall — only energy remains at its highs.
As such, it’s a good time to check in on these five attractive utility stocks to ride out the current market turbulence:
- Essential Utilities (WTRG)
- NextEra Energy (NEE)
- Global Water Resources (GWRS)
- Pinnacle West Capital (PNW)
- Northwest Natural (NWN)
Essential Utilities (WTRG)
There’s few things I like more than buying Dividend Aristocrats at 52-week lows. So that’s why we’re starting off the list with water and gas provider Essential Utilities. After a sharp reversal this past month, WTRG stock has slumped to the bottom of its 52-week trading range.
Essential began as Philadelphia Suburban more than a century ago. It rolled up water utilities and eventually changed its name to Aqua America. Following a recent acquisition in the gas market, the company became Essential Utilities.
Long-time readers will know I’m fond of water as an investment theme. There are few things more reliable, consistent, and immune to technological change than water. Gas has slightly more ups and downs, but is generally a safe haven as well. The issue with water utilities has long been valuation; the market has paid up for their combination of low volatility, high-quality earnings, and reliable dividend growth.
With the latest pullback in WTRG stock, however, shares are now flat since 2019 and only up 40% over the past five years. In a market that has gone up dramatically more than that over the same span, Essential stands out as a relative value. Shares are now offering the same 2.4% dividend yield that has been the top end of the range the stock has offered over the past five years as well.
Shares still aren’t exactly cheap for a company at 25 times earnings which compounds its earnings and dividend at roughly 7% per year. But it’s not a bad offer at this price either.
It’s hard to lose money owning a water utility if you buy at a fair price and hold for at least a few years, and there’s the possibility of larger gains if valuations go back to 30+ times earnings as they often are in the water sector. The 2.4% dividend yield with 7% annual hikes is also a reasonably strong offering from a Dividend Aristocrat, and especially one in such a low-volatility industry such as this one.
NextEra Energy (NEE)
NextEra Energy is an interesting case. In the past, I’ve been skeptical about the company’s valuation. And it’s still far from the cheapest or highest-yielding stock in the utility sector. NextEra requires some confidence in the company’s growth trajectory to own. That said, shares have pulled back sharply as of late, and this might be a decent entry point.
NextEra is now down 20% off its recent highs, and has given back virtually all gains since the start of the pandemic.
What makes NextEra interesting? It’s one of the largest developers of utility-scale solar power generation in the country. It has become a hot stock with environmental, social, and governance “ESG” investors, since it scores very well in those metrics. A lot of growth investors have made NEE stock their preferred pick for exposure to the utility industry.
However, solar stocks have slid in 2022. For one, the Biden Administration hasn’t managed to secure as much funding for green infrastructure as people might have originally expected. For another, the administration has launched an inquiry into solar panel imports which could slap large retroactive tariffs on the sector. NextEra’s CEO minced no words in condemning that policy action on a recent conference call.
Regardless, the trend toward more solar power probably isn’t going anywhere in the longer-term. If anything, the war in Ukraine makes it likely that adoption of renewables will speed up as people look to reduce dependence on fuels that Russia supplies. The recent surge in the price of natural gas will also help drive more solar adoption.
NextEra shares have fallen back to 25x this year’s projected earnings, which is significantly cheaper than they’ve been going for in recent times. If you’re not a believer in the solar story, NextEra probably isn’t the best pick, at least not at this price. However, I expect solar will get back on track reasonably quickly, and NEE stock may return to a premium valuation once this current growth bust starts to abate.
Global Water Resources (GWRS)
Global Water Resources is a small water utility focused on the Phoenix and Tucson metropolitan areas. The company is an M&A machine that is constantly acquiring new subscale water utilities in those two metro markets.
Arizona is a particularly fruitful market for this sort of strategy. Recent regulatory changes have made it much more costly for utilities to stay independent in that market. This makes it attractive for Global Water to snap up water utilities in outlying districts that own service rights covering large land areas but which don’t have many houses or businesses yet. As Phoenix and Tucson continue to grow, houses will pop up in Global Water’s service areas over the years and decades, leading to outsized growth.
Most water utilities just tend to grow at roughly the inflation rate plus population growth give or take a little bit. Global Water can grow much faster, since its home state — Arizona — is positively booming, and Global Water specifically has designed its service area so as to be right in the path of urban development. The company also has more installed infrastructure than is needed to service current customers, meaning that it should achieve solid operating scale as more homes and business customers come online.
Global Water stock is not cheap on current results. Rather, it’s a bet on Arizona continuing to grow quickly; the latest data we have on that front, from the 2020 census, confirmed that the state remains a hot market for immigrants and retirees. Global Water also rewards investors with a 2.1% dividend yield which is paid out monthly. Shares are currently at 52-week lows and approaching support from pre-pandemic trading levels.
Pinnacle West Capital (PNW)
The demographic case for Arizona also applies for power utility Pinnacle West Capital, which is primarily known for being the parent company of Arizona Public Service “APS”. In fact, Pinnacle West breaks out the bull case nicely in their investor presentation:
Maricopa is the county in which Phoenix is located.
Pinnacle West has underperformed other utilities as of late due to a rate dispute with one of their local regulators. This was an unfortunate development for people that bought at higher prices, but arguably is an opportunity for investors taking a look at shares today.
The company is guiding to $4.00 of earnings this year and 6% long-term earnings growth annually compounded off of that figure. That puts shares at 18x this year’s earnings, and with a healthy growth rate on top of that.
The company also historically has paid an above-average dividend yield for the utility industry, and that’s particularly true now as the yield has risen once again. PNW stock is now paying out 4.6%, which is — aside from a brief blip late last year — the highest it has offered over the past decade.
Northwest Natural (NWN)
Rounding out my top utility picks, there’s another income titan. Dividend king Northwest Natural has increased its dividend for more than 60 consecutive years. The company primarily distributes natural gas in Oregon and Washington. Even by utility standards, this is not a particularly exciting business.
However, it is a highly consistent one, as businesses must be if they are going to increase their dividends for more than 60 years in a row. For the longest time, Northwest Natural was too expensive to get excited about.
That has changed. Shares plummeted during the initial stage of the pandemic and have failed to mount any meaningful recovery since then.
As such, the stock is now basically flat for the past decade, with the dividend being the only source of total returns over that period.
Earnings did move up from $2.24 to $2.56 per share since 2012, indicating that the company has been able to grow to some extent. The dividend also goes up by a penny per year, which is not exciting, but is better than nothing.
The stock was clearly overvalued at $70, given the extremely modest pace of earnings and dividend growth at the business. At this price, however, shares are going for less than 20x earnings and throw off a starting 4.0% dividend yield with a little bit of growth on top of that. It’s not glamorous, but it works fine as an income holding if a starting 4% yield and a small annual bump to the coupon is sufficient for your needs.
The stock market remains highly uncertain at the moment. For investors that want to put some money to work but don’t want to gamble on speculative growth stocks, there are other alternatives.
The utilities, for example, are starting to offer some solid values and strong dividend yields as they drift down toward the bottom of their 52-week ranges. These five utility stocks in particular can give investors some equity exposure without taking undue risk if inflation or economic conditions continue to worsen.