Utilities aren’t typically the most exciting companies on Wall Street. But if President-elect Joe Biden is eventually able to reverse some of President Trump’s tax cuts, it could prove a big win for investors in power and water companies.
Utilities are legally allowed to pass higher tax expenses on to their customers. Experts aren’t predicting a major increase in rates — especially in a still-weak economy — but even a slight hike could help boost revenue and earnings for utilities as well as improve their balance sheets.
“Any change in tax law would mean that the amount of money utilities collect goes up,” said John Bartlett, president of Reaves Asset Management, which runs the Reaves Utility Income Trust (UTG) and Virtus Reaves Utilities ETF (UTES).
“There may not be a huge windfall, but it helps utilities from a credit and debt standpoint,” Bartlett added. “The bottom line is that utilities have advantages over other stocks if there is tax reform.”
Power boost coming?
Utilities could use a jolt. The Dow Jones Utilities Average (DJU) is down about 1% this year while its more famous cousin, the Dow Jones Industrial Average, is up more than 3% and not far from an all-time high. Utilities are lagging the S&P 500 and Nasdaq by an even wider margin.
But utilities might finally start to catch up. A potential increase in taxes for wealthy individuals — and not just businesses — under Biden could also push more affluent investors into utility stocks. That’s because utilities pay big dividends, which often yield more than government bonds.
“There has been a lot of interest lately in higher yielding securities, including utilities,” said Will Rhind, CEO of GraniteShares, which runs the GraniteShares HIPS US High Income ETF (HIPS). “If you are anticipating higher taxes, you also need higher income.”
Growing fears about another wave of coronavirus cases and potential state and city shutdowns also could help utility stocks because they are perceived as safer bets in a weak economy.
“Utilities are more of a defensive sector. They could get a bump if there is more economic malaise and another lockdown,” said Patrick Healey, founder and president of Caliber Financial Partners.
Healey added that as long as the Federal Reserve keeps interest rates near zero, utilities and other dividend-payers may benefit since their yields will likely remain more attractive than Treasury bonds.
Stability is key
Make no mistake. Nobody is going to confuse stodgy electric companies for the FAANGs of Big Tech. But they are a safe haven during volatile times. Businesses and consumers may cut back on discretionary spending, but they are going to keep paying their utility bills to keep the lights on.
“Power companies still have a predictable revenue stream in the Covid-19 world,” said Jeff Zananiri the head trading strategist at Joy of the Trade, an investing site.
And there are some actual growth opportunities in the utility sector as well, most notably for companies that have had the foresight to invest in renewable energy sources like wind and solar.
Zananiri said that NextEra (NEE), a Florida-based utility, is a major player in clean energy. That makes it one of the more rapidly growing and better performing utilities. Shares are up more than 25% this year and were briefly worth more than oil giant Exxon Mobil (XOM) at one point in 2020.
The transition to clean energy is also boosting utility stocks, and more power companies are going to have to get on board.
“The transition to more sustainable and renewable energy sources like wind and solar is happening. It is more economically viable,” said Jonathan Waghorn, co-manager of the SmartETFs Sustainable Energy II ETF. “The fact is that change is going to come.”
Waghorn said his fund owns shares of NextEra because of its alternative energy prowess and added that many European utilities are also worth looking at because they are ahead of the curve. Spanish utility Iberdrola (IBDRY), which is making big investments in renewable energy, is also in Waghorn’s fund.