Utility stocks are among the core holdings in most income-oriented portfolios. There are good reasons why. They’re stable, offer a dependable yield, and in most cases, increase their payouts yearly. Fortis and Canadian Utilities both boast a half-century of annual dividend hikes.
But there are two problems with these securities. The first is that they have limited capital gains potential. As regulated companies, they don’t have control over a large portion of their revenues. The rates they can charge are fixed by government agencies. So, investors shouldn’t expect to see big gains from these stocks.
The second drawback is that utilities are highly interest-rate sensitive. They invest large amounts of money in building and maintaining distribution networks, which makes them capital-intensive. When rates rise, the cost of carrying debt increases, impacting the bottom line.
That’s one of the reasons the price of utility stocks tumbled when the Bank of Canada started to push rates higher in 2022 to combat inflation. Despite speculation of interest rates cuts starting as early as this week, these stocks still haven’t shown much movement. As of the close on May 31, the S&P/TSX Capped Utilities Index was down by a fractional 0.51 per cent year to date.
But something strange is happening south of the border. U.S. utility stocks have become one of the hottest sectors of the market. The S&P 500 Utilities Index is up more than 14 per cent year-to-date, outperforming the broader S&P 500 index. What’s going on?
Artificial intelligence is what’s going on. Investors expect technology companies to spend billions of dollars in the coming years to build networks of data centres to meet corporate and consumer demand for AI-driven services. Those data centres will require huge amounts of power to operate – power that’s not yet available.
Investors seem to feel that utilities with exposure to clean energy and nuclear power will be the main beneficiaries of this new trend. In some cases, the surge in share prices is unprecedented. For example, Texas-based Vistra Corp. VST-N has seen its share price jump 140 per cent so far this year. That’s unheard of in the utilities world. Baltimore, Md.-based Constellation Energy Corp. CEG-Q is ahead 75 per cent, while Houston-based NRG Energy (NRG-N) has gained 49 per cent. All these companies have exposure to clean energy and nuclear power.
There is no Canadian public company that fits the profile of these big U.S. movers. All our nuclear facilities are provincially owned, with Ontario Power Generation the largest operator. TC Energy Corp. TRP-T is part of a partnership that operates the Bruce Nuclear Generating Station, but that’s only a small part of its business, and the stock is flat so far this year.
So, where to look? I don’t advise chasing the big U.S. gainers at this point. VST has a P/E ratio of more than 56, which is ridiculously high for a utility. The shares yield only 0.88 per cent. CEG has a P/E of more than 27 and a yield of 0.65 per cent. NRG is better, with an 11 P/E and a 2-per-cent yield.
However, I prefer Southern Company SO-N, which has some of the same attributes as the big movers and a more realistic price point. Here are the details.
Southern Company
- Type: Common stock
- Current price: US$80.41
- Annual payout: US$2.88
- Yield: 3.6 per cent
- Risk: Moderate
The business: Atlanta-based Southern Co. was founded about a century ago. It supplies power to customers in Georgia, Alabama, Mississippi and north Florida. Its facilities range from fossil-fuel plants (mainly coal and natural gas) to clean energy and nuclear. Its four Vogtie reactors, the last of which recently came online, comprise the largest generator of clean energy in the United States and are expected to produce more than 30 million megawatt hours of electricity each year.
The company’s goal is to reach net-zero greenhouse-gas emissions by 2050, with a 50-per-cent reduction by 2030.
The security: Southern has a market capitalization of US$87-billion and trades an average 4.7 million shares a day.
Performance: The stock had been bumping along in the US$60-$70 range for most of this year until it started to push higher in April. It’s up about 14 per cent year-to-date.
Financial highlights: First-quarter results were impressive. The company reported net income of US$1.13-billion (US$1.03 a share), up from US$862-million (US$0.79 a share) in the same period last year.
“All our businesses experienced a strong start to 2024,” said chief executive Christopher C. Womack. “This performance was driven by a variety of factors, including investments in our state-regulated utilities, weather that was less mild than the first quarter of last year, and higher weather-adjusted sales in our electric utilities’ commercial customer class, a fact that speaks to strong local economies and increased usage by many existing data centre customers.”
The company is guiding toward earnings per share between US$3.95 and US$4.05 this year.
Recent developments: Southern expects to add 9.5 gigawatts in electricity production capacity between now and 2030. About 80 per cent will be in non-carbon-emitting technologies, with solar power at the top of the list.
Dividends: In April, the board of directors approved an 8-per-cent dividend increase, to US$0.72 a quarter (US$2.88 a year). It’s the 23rd consecutive year that the dividend has been increased. The shares yield 3.6 per cent at the new rate. As Southern is a U.S. company, its dividends are subject to a 15-per-cent withholding tax for Canadian investors unless the shares are held in a retirement account.
Action now: Buy. The company operates in an economically dynamic region, has a strong environmental commitment and pays a respectable dividend.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.
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Gordon Pape