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Utilities may keep rising, but investors should tread carefully

Utilities stocks bested all other S&P sectors in 2014 and with cold winds blowing across much of the United States investors may be hoping for more of the same. The sector is generally considered the stodgiest of stocks given their slow-and-steady revenue growth and attractiveness to careful investors looking for high dividends. The steady decline in US government bond yields made these stocks look that much more attractive as an investment in 2014, and the S&P Utilities Index posted a total return of 29 percent for the year.

A repeat of 2014’s performance seems unlikely, especially due to expectations for a decline in earnings in the first quarter. But with low fuel prices and overseas turmoil helping to keep government bond yields low, high single-digit returns should still be in the cards for 2015, investors say. The first-quarter slowdown is something of an anomaly owing to tough comparisons with last year, when the polar vortex brought frigid weather and boosted utility bills across much of the country.

Utilities earnings, which are not generally not exposed to the weakened global economy, are expected to rise 8.2 percent this year, according to Thomson Reuters data, compared with a 7.4 percent growth rate for the S&P. “We’ve the opportunity for a high single-digit return with low risk. That’s pretty competitive with the stock market, which would be higher risk,” said John Bartlett, vice president at Reaves Asset Management in Jersey City, New Jersey, which has about $3 billion under management and a heavy weighting in utilities.

For the fourth quarter of 2014, growth is expected to come in at 11 percent. But the numbers are skewed by an expected swing to a profit at NRG. Excluding NRG, utilities earnings are seen declining 0.8 percent. The sector’s first-quarter earnings are seen declining 6 percent because of less frigid weather. Paul Ridzon, utilities analyst at KeyBanc Capital, said he sees more gains in the near term, however.

Seasoned utility investors often exclude weather from their calculations, he said, adding that utilities typically have no international exposure and should benefit from a growing US economy. They also look good compared to sectors with exposure to struggling Europe. “There’s certainly some momentum in the first part of the year. Then it’s really going to depend on the language that comes out of Janet Yellen,” said Ridzon, referring to the widely held view that the US Federal Reserve – chaired by Yellen – will raise interest rates later this year.

If the Fed raises rates, and benchmark yields start to rise, that will undermine some of the reason for buying utilities, which carry a dividend yield of 4.02 percent, according to Howard Silverblatt, index analyst at S&P Dow Jones Indices. Bond yields fell throughout 2014, driving investors to safe-haven stocks with high dividends. In the final week of the year utility-focused funds attracted a record inflow of more than $2.02 billion, according to Thomson Reuters’ Lipper service. Those funds now have about $24.6 billion in assets, compared with $16.5 billion at the beginning of 2014.

That has boosted valuations sharply: The sector’s forward price-to-earnings ratio is now about 17.4 compared with 16.1 for the broader S&P 500. Brad Sorensen, director of market and sector analysis at Charles Schwab, said investors buying utilities as a substitute for bonds should be wary. “My concern for investors chasing yield out there is that we could get a pretty quick turn around if you get a little upward momentum in yields in the fixed-income side,” he said.

Sinead Carew, "Utilities may keep rising, but investors should tread carefully," Business recorder. 2015-01-11.
Keywords: Economics , Economic issues , Economic system , Economic growth , Economic development , Economy-United States , Global economy , Oil prices , US federal reserve