Utilities & Power

Challenging times for the market can be a time for lower-risk utilities to shine and the sector has started out strongly so far in 2020. Through our launch pricing (Feb 21) the group was up 8% on the year and had outperformed the broader market by 500bp, edging out Tech to top the sector league table.

Interest rates falling doubtless has provided some fuel, but many utilities are also offering an attractive package of high-certainty, mid-single digit earnings growth and ~3% average yields. Risk-adjusted such fundamentals are appealing to investors confronting a low-growth, muddle-through economy and scary macro overhangs. Where better to hide out from COVID-19 fears than a 100% domestic regulated industry which delivers its product via wire and pipe? Standing back, we see powerful secular trends at work: demographics favoring income; global demand for listed infrastructure; and growing investor focus on ESG. As earnings calls are highlighting, low-cost renewables and other new technologies offer even sleepier electric utilities opportunities to grow the earnings base, while at the same time serving customers with an essential product that is cleaner, reliable and often cheaper than before. Such factors seem likely to extend a long-running CapEx cycle, with technology (broadly defined) picking up where cheaper fuel and financing left off as the marginal source of investment headroom on the customer bill. We rationalize a strong regulated premium against solid fundamentals and current market uncertainties. Even so, we are wary of downside risk if the macro climate turns for the better, with only relative protection if the economy and/or market roll over.

The picture is a good deal murkier for hybrids (EXC, PEG) and merchant energy retailers (NRG, VST), although de-leveraging, hedges and de-risking via retail mean commodities are no longer the recurring existential threat of old for the IPPs. Capacity markets, principally PJM, are dealing with a clash of civilizations between states wanting to subsidize preferred resources (nuclear, renewables) and federal oversight by the FERC. This struggle looks set to continue well into 2020, with little sense yet as to how, or when, the FERC will bring the issues to a head, nor how states and market participants will respond. Texas (ERCOT) remains the exception, with rule changes finally bringing desired scarcity pricing last summer and forwards pricing in further price action this year. How ERCOT summer curves hold up in a risk-off tape will for sure bear watching.

Top Picks:

  • NRG Energy (NRG)
  • Vistra Energy (VST)

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Jonathan Arnold

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