Why Every Growth Stock Portfolio Should Be Overweight In Utilities

Topline: While utilities have long been viewed as a safe investment for coupon-clippers, low-cost renewable energy like solar and wind power are quietly transforming the sector, resulting in strong earnings growth and making for an attractive long-term investment, according to global asset manager T. Rowe Price.

  • The trend toward low-cost energy renewables increasingly replacing coal and natural gas is pervasive. This will create a “flywheel that can benefit everyone,” as it provides more clean energy for regulators at a cheaper cost to customers, says David Giroux, T. Rowe Price’s head of investment strategy.
  • Utilities stocks have been seen as defensive safe havens, rather than growth oriented: With decades of little to no earnings growth, returns mostly came from dividends, the yield of which is highly correlated to interest rates on Treasuries and corporate bonds.
  • “The conventional wisdom about utilities is outdated,” Giroux says. Thanks to “changing industry dynamics” from the rise of renewables, utilities earnings are growing at a faster rate than before, making it the only defensive sector without secular risk unlike consumer staples. They are immune to foreign exchange risk and their so-called beta or market correlation risk is 25% of the S&P 500. Even if a recession hits, utilities will keep growing, while the rest of the market won’t.
  • Over the next five to ten years, utilities stocks will actually grow earnings at a faster clip than the S&P 500, potentially at a rate of 5% or more. Add in dividend yields and double-digit returns are likely, T. Rowe Price predicts. 
  • The T. Rowe Price Capital Appreciation fund which Giroux heads, for instance, has over 13% of its holdings in utilities, compared to a category average of just under 4%.
  • Some of T. Rowe’s favorite stocks in the utilities sector that are leading the way in renewables right now include American Electric Power, Excel Energy and NextEra Energy. Some of the big names in the industry, like the Southern Company, Duke Energy and Dominion Energy, are a bit further behind the curve in implementing low-cost renewables, according to Giroux.

Crucial quote: “Utilities should be a core part of a portfolio for the long term investor,” Giroux says. “The view that utilities are a yield play with no earnings growth is no longer supported by the facts.”

Big numbers: Renewables account for 18% of energy generation today—within 20 years, that figure will rise to more than two-thirds of energy generation, Giroux predicts. With renewables bringing down utility costs over the next decade, that could lead nearly a dozen utilities companies to deliver 6% earnings growth and a yield of 3%. As solar and wind power gets implemented on a widespread basis, that will drive strong rate-based growth for the utilities sector, crucially doing so without driving up customer bills.

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