Merrill Lynch Picks the Winners and Losers of the Utilities Sector

At this stage, the Fed rate raise could potentially act as the removal of an overhang on the utilities group rather than a negative catalyst.

The group still has a modest level of downside relative to bond yields, but has mostly priced in Fed action in the second half of 2015.

Within the utilities space, broader macro fears surrounding China or Greece have prompted an intra-sector bounce in the past month to the more traditionally positioned electric utilities, including Duke Energy Corp. (NYSE: DUK) and Southern Co. (NYSE: SO). Merrill Lynch believes that investors looking to the group should not be focused on these names at this stage. Instead NextEra Energy Inc. (NYSE: NEE), American Water Works Co. Inc. (NYSE: AWK) and Edison International (NYSE: EIX) are preferred.

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NextEra Energy and American Water, both beat first-quarter consensus expectations and did not change guidance. Neither is entering a difficult stage in its rate case cycle. NextEra also received constructive approval of its gas infrastructure proposal by Florida state regulators. American Water historically does not alter its guidance until the third quarter, but Merrill Lynch’s recently noted management confidence in the outlook.

Additionally, forward commodity prices have deteriorated due to a confluence of factors, causing underperformance in integrated utilities and sharp underperformance in independent power producers.

Merrill Lynch believes a short-term constructive stance on the power cycle is merited in this case, and that the independent power producers appear well positioned for a rebound in forward electricity prices.

Duke shares were up 0.8% at $74.62 late on Thursday. The stock has a consensus analyst price target of $81.41 and a 52-week trading range of $69.48 to $89.97. Merrill Lynch has an Underperform rating for Duke with a $75 price target.

Shares of Southern Company were up 0.9%, at $43.74 in a 52-week trading range of $41.40 to $53.16. The consensus analyst price target is $45.59. The brokerage firm has an Underperform rating for the company with a $42 price target.

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NextEra shares were up 1.5% to $104.26, in a 52-week range of $90.33 to $112.64. The consensus price target is $117.28. The firm has a Buy rating for NextEra with a $120 price target.

Shares of American Water were up 0.9% at $51.73. The consensus price target is $56.80, and the 52-week range is $45.98 to $57.48. Merrill Lynch has a Buy rating with a $55 price target for this company.

Edison shares were up 1.7%, at $59.11 in a 52-week trading range of $54.12 to $69.59. The stock’s consensus analyst price target is $66.58. The firm has a Buy rating for Edison with a $66 price target.