Beyond Interest Rate Hikes, Problems or Contrarian Dream for Utilities Stocks?

The utilities sector has been one of the key sources for income investors to get dividends. 24/7 Wall St. once went as far as to say that utilities had become “the new CD market” for retirees and income investors. Well, it turns out that 2015 has not been very kind to the utilities sector, ahead of the Federal Reserve’s expected interest rate hike cycle into 2016.

Utilities are substantial borrowers of capital, via debt of course. So higher interest rates drive up their fixed borrowing costs, which drives up their operating costs, in a manner that may not be offset by price hikes.

Going into 2016 could spell even more trouble for utilities. The Federal Reserve’s report on industrial production and capacity utilization for November was particularly brutal for the utilities sector. The blame is on exceptionally warmer weather (like 65 degrees in New York City), but the reality is that the manufacturing, energy, mining and other industrial efforts all are in the red. So unless everyone is charging up electric cars and keeping all their lights on and appliances running on overdrive, it means that utilities are suffering from more than just warm weather.

As far as the utility stocks themselves, one thing that long-term investors might want to consider is whether things simply got too negative. Could the contrarians be setting up for a dream trade in 2016 and beyond?
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Some of the utilities actually are rising ahead of rate hike decision and after the poor output and capacity reports. 24/7 Wall St. has outlined the performance for the four top utilities and for the key utilities exchange traded fund to show how the markets are reacting here.

Duke Energy Corp. (NYSE: DUK) shares were last seen trading up 1.5% at $69.87, with a consensus analyst price target of $75.42 and a 52-week trading range of $65.50 to $89.97. The company also has a market cap of $48 billion and a dividend yield of 4.9%. Duke’s stock performance is down 14% year to date.

NextEra Energy Inc. (NYSE: NEE) saw its shares recently trading up 2.9% at $101.61. The stock has a consensus price target of $118.32 and a 52-week range of $93.74 to $112.64. The market cap is nearly $47 billion, and the dividend yield is 3.2%. NextEra’s drop in 2015 has been just over 4%.
Southern Co. (NYSE: SO) shares were trading up 0.8% at $45.79, with a consensus price target of $45.53 and a 52-week range of $41.40 to $53.16. Its market cap is just over $41 billion, and the dividend yield is 4.9%. Southern Co. is not really looking “southern comfort” but is down only about 3% so far in 2015.

American Electric Power Co. (NYSE: AEP) shares were recently trading up 1.4% at $56.80, with a consensus price target of $62.40 and a 52-week range of $52.29 to $65.38. The company has a market cap of nearly $28 billion. The dividend yield is 4.1%. Shares down just over 4% so far in 2015.

Utilities Select Sector SPDR ETF (NYSEMKT: XLU) is the key utilities exchange traded fund. Its shares were last seen up almost 1.4% at $42.90, in a 52-week range of $40.80 to $49.78. The addition of its last four dividend payments would generate a yield of roughly 3.7%. This SPDR ETF has a weighted-average market cap (according to SPDRS.com) of almost $26 billion, making it among the largest ETFs. It is down roughly 8% so far in 2015.
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The long and short of the matter is that industrial production and capacity utilization look very poor. Still, markets try to discount for what may be coming months down the pipe. Maybe the market is thinking that enough is enough and that the utilities as a sector have been oversold. Maybe. Or maybe the market just thinks that interest rates will remain incredibly low for way into the future. Below are some of the comments regarding utilities from the Fed for November’s capacity utilization and industrial production:

• The index for utilities dropped 4.3%, as unusually warm weather held down the demand for heating.
• Industrial production for utilities fell to 97.6% in November, down from 102.0% in October.
• To make matters worse, this 4.3-point drop on a monthly basis is even less of a drop from a year-over-year basis of -7.6 points.
• Utilities ran at a mere 74.5% of capacity in November, down 5.4 points from a month earlier but up 0.8 points from a year ago.

Wall Street strategists are looking for small gains in 2016, with 14 strategists looking for mostly single-digit gains in the 2016 S&P 500 outlooks.