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Utilities for Safety—and Dividends

December 19, 2018

Utilities make for one of the most reliable stock sectors for both longer-term growth and regular to rising income. They serve that function particularly well during times of market strife due to the reliability of demand for their core products and services.

If you think that they underperform the general stock market, you’d be wrong. Over the past 20 years, US utility stocks, as tracked by the S&P Utilities Total Return Index, have outperformed the general stock market as tracked by the S&P 500 Index.

The market for utilities isn’t about sacrificing return for just dividend income—rather, it can be a potent rival for the returns you expect from more growth-oriented stocks.

What’s more, utilities can be a great defensive counterweight in your portfolio.

For example, during the recent market rout from October to date, the S&P 500 index was down very heavily, by 12.06%. But during that same time, utilities managed to outperform with a positive return of 3.96%

This is all thanks to the combination of reliable core business assets and higher dividend payments that utilities represent.

Of course, not all utilities are the same. They can include a host of essential services including electricity, natural gas, and water. And they are comprised of both regulated and unregulated businesses.

Regulated business means that the companies have contracts set with specific rates for gas, electricity and water that are set by local public utility commissions (PUCs).

This means that the companies with regulated markets must lobby local PUC officials for acceptable rates that take into consideration the cost of providing the services as well as the capital costs of the operations for the services.

In addition, PUCs, along with other regulatory bodies, must approve any expansion of regulated services, including new plants and transmission or other conveyance lines. And they also need to gain approvals for payments for upkeep and repairs.

All of this takes a wide array of skillsets by management to make the most for shareholders while keeping customers and their PUCs content. This includes negotiating and lobbying as well as budgeting and market supply-and-demand forecasting.

Yet, at the same time, regulated business means that companies can conduct longer-term budgeting for capital expenditures as well as having better forecasting for revenues and profitability.

This means that utilities can provide smoother performance for shareholders, especially in challenging times. That adds stability for investors over the long term.

Then there is the unregulated part of the utility market. This can include wholesale provision of essential services for industries as well as for other local utility companies that will contract for gas, power or water.

This is where some companies can provide larger-scale services across local markets and even across the country. The companies in this space can provide the opportunity for investors to cash in on their success in markets with less regulatory oversight on rates.

One of the best utilities in the market is NextEra Energy (NEE). The company is primarily comprised of two operating units that take advantage of both the regulated and unregulated power utility market.

Based in Florida, NextEra has its primarily regulated power company in Florida Power & Light. The operation provides power through a variety of generating sources, including natural gas, coal and oil as well as nuclear power plants. Its customers number in the millions and are primarily residential customers, with some commercial customers.

In addition to its own power generation, it also contracts with external power generators that transmit power via the power grid to supplement its own power generation.

The other side of the company is Next Era Energy Resources. This division of NextEra provides unregulated wholesale power around the US with some additional assets in Canada and Spain.

Much of its power generation comes from traditional power plants—but increasingly wind and solar generation provides a large portion of its power. It has quickly become one of the largest renewable power generation companies.

In addition, NEER also has some petroleum and natural gas pipeline assets that take advantage of the company’s reach across the US.

Revenues from the regulated FPL side of the company represent the larger sum of revenues, which continue to expand at a reliable three-year average of 1.58%. This makes for a steady cash flow for the company.

The company continues to focus more on the NEER division, which provides the namesake for the overall company. The idea is that the next era in power generation will be ever more focused on renewable energy sources. This is supported in that the revenues for the NEER unit have expanded to become 28.55% of overall revenue of the company.

The industry is benefiting from state and local legislation around the nation requiring that a portion of power be generated by renewable sources. In addition, NextEra’s renewable power expansion is also benefitting from Federal tax credits for renewable energy facilities. These come based on capacity and not just the amount of power generated. This means that the company can operate wind and solar facilities around the nation and not just in areas that are particularly sunny or windy.

The company is a stronger performer for investors. The return on its capital is running at 13.1% while the return on investor’s equity is a whopping 27.9%. And this is resulting in the market recognizing its performance now and for the future. The shares have delivered a total return over the past five years of 132.81%, which is more than double the return of the S&P 500 Utility Index.