Investors Avoid Utility Stocks in 2023

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Most investment portfolios held utility stocks. They have always been one of the most reliable sectors of the stock market. Historically, utilities stocks have been a low risk with high yield. But that has changed.

Unlike growth stocks, many investors hold utilities to collect dividends. But these once-healthy dividends have dried up. Why did this happen? And how risky are utility stocks in 2023?

Utilities Traditionally Stable

Many investors who want lower-risk investments typically turn to utility stocks. Electricity is a modern necessity that people can’t do without. Consumers may cut back on other goods, but they’re going to turn the lights on and heat their homes regardless of the economy.

State or federal policymakers regulate most utilities. The result is a higher barrier for competitors to step in and offer lower rates. In the United States, utilities are regional monopolies that are traded publicly.

Because of this and the high dividend yield utility companies provide, investors have usually incorporated these stocks in their investment strategies.

Utilities Help S&P 500 Fall in Third Quarter 2023

The benchmark S&P 500 Index was pummeled by sectors that were victimized by inflation and higher interest rates. These sectors included consumer staples, real estate, and utilities.

Led by utilities, the S&P 500 fell 3.65 percent in third quarter 2023. Utilities took the second-biggest loss in the index. Throughout the quarter, utilities dropped 10.09 percent.

The biggest losers were AES Corporation (AES), down 26.68 percent, and NextEra Energy (NEE), down 22.79 percent.

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But utility stocks were about to take another hit.

Utility Sector Continues Decline

As of the first week of October 2023, the S&P 500 utility sector was down 21 percent. It dropped 12 percent in two weeks. This underperformed the broader index’s 11 percent gain.

NextEra Energy plummeted further this month by 52 percent, with AES Corp. losing 37 percent.

Paying the formerly healthy dividends is disappearing. NextEra Energy Partners, a subsidy of NextEra Energy, slashed its dividend forecasts in half. This worries investors into thinking that the parent company Next Era Energy will revise its earnings growth because of its subsidiary’s downward spiral.

Utilities haven’t been this far behind since 1999, when the sector fell 9 percent. This was fueled by the dotcom bubble breaking.

But why the downward turn? There are several reasons the utility sector is in a nosedive.

US Treasury Notes Climb

Electricity and water supplier stocks typically offer dividends. And since this hovers around 5 percent, they look attractive to investors who want low-risk, high-yield returns.

For the last 15 years, the utility sector averaged about 1.05 percent points higher than the 10-year U.S. Treasury note. This rewarded conservative investors for the added risk of utility stocks. But the yields have changed.

Risk-free Treasurys have seen rising interest rates. As of this writing, two-year Treasurys touched 5.1 percent. The 10-year note hovers around 4.8 percent.

Conservative investors can purchase risk-free Treasurys and receive the same returns they were seeing with the utility sector.

Inflation Hurts Utilities

High inflation rates impact a utility company’s borrowing costs. This affects all businesses but is a major issue with utilities. Utilities usually have high debt levels.

Major utility firms have higher capital expenditures and high debt-to-market cap levels. It takes a lot to maintain and expand utilities. Renewable energy projects are capital-intensive. There are constant upgrades to the power grid.

Power plant construction maintenance and the infrastructure all take financing. Low interest rates have provided low-cost money over the past few years, but things have changed.

Of course, the higher costs could be passed onto the customers, but with regulations, that isn’t always possible. At that point, the equity investors and bondholders bear the costs.

This makes utility companies less attractive.

Fires Destabilize Utility Stocks

The abundance of fires has hit utilities. Homes and buildings aren’t the only items up in flames. A fire can devastate a utility’s infrastructure.

Utility companies have also been blamed for fires or at least escalating them. For example, Hawaiian Electric took a share price collapse. It plunged 65 percent. This is due to potential litigation from its equipment’s role in spreading the fire.

In 2019, PG&E, a California utility, filed for bankruptcy because of a series of costly fires. It was blamed for using outdated equipment.

Utilities Decline Could Be an Opportunity

Utilities aren’t going anywhere. People still need to turn the heat on in their homes. In 2020, when the dotcom dust had settled, utilities saw a 57 percent gain. This compared with the S&P 500’s 9 percent drop.

So, in hindsight, when the bottom fell out, it was a great time to buy.

But how long will it take for the utility sector to climb out of its hole? With inflation continuing and Treasurys high, it’s hard for investors to swallow hard and buy utilities. Many may stay with the “wait and see” strategy.

The Epoch Times copyright © 2023. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.