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A Mixed Report Card

Now that more than 90% of S&P 500 companies have reported earnings for the calendar second quarter, we have enough data to see how utilities stacked up against the other nine major sectors.

This latest earnings season continues with the two major themes in the utility space: Weak or declining electricity demand has weighed on revenue, while the infrastructure buildout continues to boost earnings.

The former means that utilities were one of four sectors to post second-quarter sales declines, with revenue among the 28 utilities in the S&P decreasing by an average of 2.4%.

And while this macro theme is well understood by analysts, utility sales still managed to fall below expectations, missing Wall Street estimates by an average of 5.3%.

Earnings growth was an entirely different story. Utilities grew earnings by an average of 8.9% during the second quarter, ranking them second among the S&P’s 10 sectors, just behind consumer staples.

In contrast to their top-line performance, utilities’ robust earnings growth also exceeded analyst expectations by 6.2%, for the second-biggest average upside surprise among the S&P’s 10 sectors.

Looking at individual companies, the two regulated utilities that managed to produce meaningful growth in both sales and earnings were the Midwestern electric utility Alliant Energy Corp. (NYSE: LNT) and American Water Works Inc. (NYSE: AWK), which is by far the largest publicly traded water utility.

Alliant grew second-quarter earnings per share by 10%, to $0.37, on a 5% rise in revenue, to $754.6 million. Analysts expect the firm to grow earnings per share by 9% for full-year 2016, to $1.90, on a 3% increase in revenue, to $3.3 billion.

AWK grew second-quarter earnings per share by 13%, to $0.77, on a 6% increase in revenue, to $827 million. Analysts forecast earnings growth of 8% for full-year 2016, bringing earnings per share to $2.83, on a 6% rise in revenue, to $3.4 billion.

Utility stocks have been one of the market’s few bright spots in a year marked by turmoil and uncertainty.

Although many utilities have seen their share prices retreat from all-time highs in recent weeks, the S&P 500 Utilities Sector Index is still up 17.1% on a price basis year-to-date, compared to just 6.8% for the S&P 500 as a whole.

Given utilities’ elevated valuations, we believe a further decline—or even an outright correction—would probably be healthy for the sector in the near to medium term.

To be sure, both utilities and the market are expensive right now, though their valuations have started to diverge. The 28 utilities in the S&P 500 currently have a price-to-earnings ratio of 18.8x, down from a recent high of 19.6x, while the index as a whole currently trades at 20.5x.

Equally important, a correction would also give us an opportunity to buy some of our favorite stocks at more reasonable prices.

Even though we recently adjusted our approach to setting buy targets for portfolio holdings, there’s no getting around the fact that many utilities are fully valued at current prices, while a sizable minority trade well in excess of fair value.

Looking ahead, the 28 utilities in the S&P 500 are expected to grow earnings per share by 2.8% over the next 12 months, on a 7.9% rise in revenue.

By contrast, the market is projected to grow EPS by 16.7%, on a sales increase of 6.3%, over that same period.

Interestingly, the market is also forecast to produce superior dividend growth over that same period, with dividends per share expected to rise 7.2% versus 4.9% for utilities.

Of course, that dividend growth is coming from a much lower base, given the market’s current yield of 2.1%, compared to 3.3% for the utility sector. So when it comes to dividends, we’re still sticking with utilities.


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