Rate Hike Worries No Bar: 5 Utility Gainers In September
Zacks Investment Research | Oct 02, 2016 10:42PM ET
Global financial market conditions continue to remain weak thanks to the ongoing crude price volatility, lower-than-expected recovery in some regions and Britain’s vote to exit the EU. The upcoming U.S. Presidential election is further contributing to the uncertainty. Also, a stronger dollar continues to hurt U.S. manufacturers.
In such a situation, investing in the fundamentally strong and mature utility sector is a viable option for investors to overcome market volatility. Demand for utility services like electricity, gas and water is not susceptible to market fluctuations and therefore the fortunes of these companies do not swing as much as others in response to cyclical changes in the economy. After all, these companies provide basic services that can never go out of business and this is their fundamental strength.
Stocks of utility companies enjoy a reputation for safety, owing to the regulated nature of their business. This gives their revenues a high level of certainty. In addition, the ability to boost shareholders’ value through consistent dividends and share buybacks makes them all the more attractive.
To provide an uninterrupted supply of basic amenities, utilities need to upgrade and strengthen their infrastructure and modernize the generation fleet. These capital intensive utilities therefore routinely take recourse to the capital markets to meet the above requirements. Though the regulated utilities are cash generators, the funds generated from internal sources are not sufficient to carry out long-term projects. Given their business model, a low interest rate scenario helps them to get the much-needed funds on favorable conditions.
However, the increase in interest rate by the Federal Reserve in Dec 2015 raised the cost of capital for the utilities to some extent. Another round of rate hikes before the end of this year might further increase the cost of capital of the defensive utilities and can eat into profits, which are otherwise distributed as dividend.
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