Editors' Pick: Originally published Dec. 29.
With an average decline of almost 8%, according to according to Fidelity Investments --grossly underperforming both the S&P 500 (SPX) and the Dow Jones Industrial Average (DJI) -- the utilities sector suffered numerous blackouts in 2015. Or so it would seem.
As a group, in 2015 the utilities sector was third among the worst-performing sectors to invest in. The 8% year-to-date decline Utilities Select Sector SPDR Fund (XLU) -- home to prominent utility stocks like Duke Energy (DUK) (down 14%) and NRG Energy (NRG) (down 58%) -- would suggest there were no places to hide in 2015. Take a look at the chart.
DUK Year to Date Total Returns (Daily) data by YCharts
Save for TECO Energy (TE) and AGL Resources (GAS) , which has gained 30% and 16% year to date, if you were a utilities investor in 2015, you're likely in the hole. It's true, utility stocks aren't sexy -- not to the extent of, say, technology or banking, but this year's performance is nonetheless a surprise, especially after utilities posted 2014 average gains of almost 30% -- leading all other groups.
The reason for their collective struggles? It could be because interest rates are expected to rise -- albeit gradually in 2016. Despite their generous dividends, higher rates makes utility stocks somewhat less attractive. Plus, many utility companies have had to sacrifice portions of their profits to invest in their facilities and power plants. Upgrading their systems costs tons of money.
And while capital expenses aren't always inherently a bad thing, in the case of utility companies, they've often passed those expenses to their customers. In 2015, however, federal regulators have pushed back, making it harder to past those costs. So not only does that impede their revenue, it's tough to get an immediate return on those facility upgrades. Not to mention, utility companies have begun facing competitive threats from alternative forms of energy like solar.
All told, utilities are getting hit from multiple angles. And this would explain the need for consolidation as we have seen recently from Duke Energy, which announced a $4.9 billion deal for North Carolina-based Piedmont Natural Gas (PNY) . This proposed deal comes a year after Duke picked off Progress Energy in 2014. Given the challenges utility companies continue to face, investors should expect more dealmaking in 2016.
In that vein, one name to keep an eye on is PG&E (PCG) , one of the largest combined natural gas and electric utilities in the U.S. With its shares up about 1% in 2015, the San Francisco-based company has been a relative out-performer. Sure, revenue has been hard to come by, but the company continues to make money and has beaten Wall Street's earnings estimates in four of the last five quarters.
Like Duke Energy, PG&E is looking for ways to grow its customer base and can use M&A as an option. The company continues to make infrastructure investments to its boost capacity and the number of customers it can effectively service. Assuming it does earn $3.04 a share for 2015, this puts PG&E on track to grow earnings in 2016 by about 23% year over year, reaching $3.75 a share. And investors would only pay 13 times forward earnings for that growth -- four points lower than a forward P/E of 17 for the S&P 500 index.
And if you're looking for a solid bounce-back candidate, Dominion Resources (D) belongs on your watch list. With four consecutive earnings beats under its belt, you would be hard-pressed to find a better-performing utilities company. But with its shares down some 12% on the year and 14% in twelve months -- Dominion is grouped in with its peers.
From my vantage point, investors would be better served to focus on the long term. Not only does Dominion have a consensus buy rating, there's an implied 18% stock gain, based in its average 12-month price target of $80 -- about $13 higher than where D stock trades today. To top it off, Dominion pays quarterly dividend of 64.75-cents a share, yielding 3.83% annually -- almost twice the 2.00% average yield of the S&P 500 index.