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Utility stocks: is 2020 the year to invest?

By Connor Freitas

Utility stocks are often attractive when the markets slip into the red. Is the same going to be true for 2020?

When fears of a recession or a market slowdown rear their ugly head, utility stocks start looking more attractive for investors. Companies that provide water, electricity and gas to the masses are often regarded as a safe bet because of how their services will be relied on by millions of people – irrespective of the economic climate. Here, we’ll assess the expert opinion on whether investing in utility stocks this year is a good idea, and analyse how the sector has been performing of late.

What is the utilities sector?

Whenever a bill hits the doormat for keeping the lights on, your gas heating warm and the tap water running, you’re paying a company in the utilities sector – that is, unless you live in a country where these services have been nationalised and taken under state control.

Browsing the stock market, you’ll notice that some companies are focused on one particular utility, while others offer a multitude of services. Long-established utility market trends show share prices in this industry don’t usually suffer the same levels of volatility as sectors such as technology. This doesn’t mean that utility stocks are continually popular – when the market is booming, they tend to be given the cold shoulder because of their rather modest dividends.

Utilities industry analysis

So… how did utilities perform in 2019? Well, fascinatingly, figures from Fidelity actually show that this sector outpaced the S&P 500 over the past 12 months. At the time of writing, companies in this industry have enjoyed share price growth of 28.5 per cent – comfortably ahead of the wider index of 25 per cent. This impressive performance was powered by electric utilities firms, which posted growth of 30.2 per cent, more diversified multi-utilities on 22.1 per cent, and, to a lesser extent, independent power and renewable electricity producers on 9.6 per cent.

Although this data may make it seem like renewable energy is an unattractive proposition, adopting such a view may prove short-sighted. The infrastructure used to deliver utilities is aging and in desperate need of upgrades – especially in the US. Many companies are aggressively investing in more eco-friendly energy sources as they strive to bring the network into the 21st century. According to Deloitte, this strategy is beginning to bear fruit: 22 per cent of America’s capacity was delivered by wind, solar and hydroelectric last year – surpassing the contribution of coal-fired plants for the very first time.

The challenge that lies ahead for many top utility stocks now is the pressure that high levels of capital expenditure, often fuelled by debt, have on their bottom lines. Although several nations have been introducing policies to encourage investment as concerns over the climate crisis grow, economic superpowers such as the US have been reneging on some of their environmental rules. It’s also worth bearing in mind that the red ink on the balance sheets of utility companies can prove problematic when base interest rates rise – principally because this sees the cost of borrowing go up. The US Federal Reserve cut interest rates twice in 2019 – ultimately to a level of 1.75 per cent – and although there appears to be no plans to increase them again in 2020, any future rise will drag down the sector.

Investment in this industry isn’t just about transitioning to renewables and chasing new revenue streams by rolling out a network of charging stations for electric vehicles, though. Much of the cash being spent is geared towards protecting the network against real and tangible threats. Hurricanes and wildfires placed the utilities sector under pressure in 2019, prompting debate on how to enhance resilience against natural disasters. Deloitte adds: “At the same time, cyberattacks on the electric grid have increased and become more targeted in recent years, requiring power companies to continue fortifying their defences.”

Utility market trends for 2020

Let’s wrap up by looking at utility market trends for the coming year. There seems to be a divide on whether utilities are a desirable sector to invest in depending on which side of the Atlantic you live. The Schwab Center for Financial Research has predicted that the industry will underperform when compared with the wider S&P 500 in the US this year. Noting that utilities have “experienced poor momentum relative to other sectors”, its experts added: “While defensiveness can be attractive in uncertain times, we are increasingly concerned about valuations, which have risen to well above historical levels both on an absolute basis and relative to the other sectors.” Credit Suisse has also downgraded its forecast for utilities – along with real estate investment trusts, communications and consumer staples.

Contrast this with the outlook in the UK. Some analysts, such as Helal Miah at The Share Centre, believe that British utilities shares are currently trading at low valuations – and think investors will return despite their tepid performance in 2019. One of the biggest threats for the industry was Jeremy Corbyn’s plans to begin renationalising energy and water companies within 100 days of becoming prime minister, but he and Labour suffered a resounding defeat in the polls against Boris Johnson’s Conservative Party late last year.

Ultimately, there’s little doubt that the utilities industry of 2030 will be unrecognisable from the sector we see today. Backing companies that are getting an early headstart in pursuing renewable alternatives could prove astute – and with the US election, the coronavirus and the global economic slowdown all having the potential to weigh heavily on the stock markets this year, timing an entry into the utilities sector could prove decisive.

FURTHER READING: S&P 500 forecast for 2020

FURTHER READING: Consumer discretionary: sector predictions for 2020

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