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Impact of the Fed's Easing Cycle on Utility Stocks

August 14, 2024

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

  • Utility stocks are highly sensitive to interest rate changes, impacting earnings due to increased interest expenses and higher debt levels.
  • Despite rising capital costs, utility companies are increasing capital expenditures to expand systems and invest in renewables.
  • Utility companies are experiencing increased debt levels and interest expenses, necessitating refinancing and leveraging low-cost financing sources.
  • Utility companies are maintaining or increasing dividend yields, providing attractive returns and financial flexibility.
  • A constructive regulatory environment supports capital deployment and growth, crucial for the utility sector's stability and expansion.

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Interest rate sensitivity of utility stocks

Utility stocks are highly sensitive to interest rate changes, as evidenced by increased interest expenses and higher debt levels impacting earnings at Exelon, NextEra Energy, and Xcel Energy. Duke Energy highlights that a stabilizing interest rate environment supports investment and growth, underscoring the sector's vulnerability to rate fluctuations.

"Earnings are lower in the first quarter relative to last year driven primarily by $0.04 of higher interest expense due to the rise in interest rates and higher levels of debt at the holding company and at some of our utilities." --- (EXC, earning call, 2024/Q1)

"ENERGY MARKETING AND TRADING AND MARKET RISK SENSITIVITY NEE and FPL are exposed to risks associated with adverse changes in commodity prices, interest rates and equity prices." --- (NEE, sec filing, 2024/Q1)

"Interest Charges — Interest charges increased $51 million for the second quarter and $89 million year-to-date, largely due to increased debt levels and higher interest rates." --- (XEL, sec filing, 2024/Q2)

"This accelerating load growth that pointed more towards the back end of the plan, clearly provides a tailwind, consistent investment in critical infrastructure across our jurisdictions that are supported and approved by multiyear rate plans or grid riders for multiple years to come provide that transparent growth and a stabilizing interest rate environment." --- (DUK, earning call, 2024/Q2)

"All other impacts reduced earnings by $0.12 per share. This decline reflects higher interest costs of $0.07 per share, half of which related to new borrowing costs to support new investments." --- (NEE, earning call, 2024/Q1)

Impact on capital expenditure

Utility companies are increasing capital expenditures to expand systems, invest in renewables, and meet customer demands despite rising capital costs. This trend is evident in Xcel Energy, NextEra Energy, Exelon, Duke Energy, and Southern Company, reflecting a sector-wide commitment to infrastructure and clean energy investments.

"The increase in capital expenditures was largely due to continued system expansion and increased investment in renewable projects." --- (XEL, sec filing, 2024/Q1)

"Over the current four year settlement agreement, we expect FPL's capital investments to exceed $3 billion, $4 billion.FPL's second quarter retail sales increased 3.7% from the prior year comparable period due to warmer weather, which had a positive year-over-year impact on usage for costumer of approximately 2.6%." --- (NEE, earning call, 2024/Q2)

"(5) Reflects ongoing capital expenditures across all utilities. (6) For PHI, primarily reflects an increase in interest expense and an increase in taxes other than income." --- (EXC, press release, 2024/08/01)

"The outcomes support essential critical infrastructure investments acknowledging the rising cost of capital through higher ROEs and allow us to meet our customers' demands for affordable, reliable and increasingly clean energy now and into the future." --- (DUK, earning call, 2024/Q2)

"The Registrants' significant cash requirements include estimated capital expenditures associated with their construction programs and, for the traditional electric operating companies, operating cash flows related to fuel cost under recovery." --- (SO, sec filing, 2024/Q1)

Impact on debt levels

Utility companies are experiencing increased debt levels and interest expenses due to higher outstanding debt balances and interest rates. Companies like AEP, DUK, and XEL report rising interest charges, while NEE and SO highlight the need for refinancing and leveraging low-cost financing sources.

"top left table, you can see the FFO to debt metric stands at 14.6% for the 12 months ended June 30th, which is a 40 basis point increase from the prior quarter.Our debt-to-cap decreased slightly from last quarter and was 62.6% at quarter end." --- (AEP, earning call, 2024/Q2)

"Interest Expense. The increase was primarily due to higher outstanding debt balances and interest rates. Other" --- (DUK, sec filing, 2024/Q2)

"Interest Charges — Interest charges increased $38 million for the first quarter, largely due to increased long-term debt levels and higher interest rates." --- (XEL, press release, 2024/04/25)

"Of course, we need to go out and raise the asset level financing and we need to refinance our existing corporate debt." --- (NEE, Investor Day, 2024/06/11)

"So that's a significant amount of debt financing that could be done through a very low-cost source relative to the capital markets." --- (SO, earning call, 2024/Q2)

Influence on dividend yields

Utility companies like NextEra Energy, Xcel Energy, and Southern Company are maintaining or increasing their dividend yields, with strategies targeting annual increases and stable payout ratios. This approach provides attractive returns and financial flexibility, suggesting that the Fed's easing cycle supports robust dividend policies in the utility sector.

"We have a track record of beating consensus estimates, while our peers in the broader market have historically underperformed. Adding our attractive dividend yield together with a low beta, we have offered a compelling risk adjusted return over any time period that you measure, take your pick." --- (NEE, Investor Day, 2024/06/11)

"Deliver annual dividend increases of 5% to 7%. Target a dividend payout ratio of 50% to 60%." --- (XEL, press release, 2024/04/25)

"Over to Chris, I'd like to highlight our most recent dividend increase. Last week, the Southern Company Board of Directors approved an $0.08 per share increase in our annual common dividend, raising the annualized rate to $2.88 per share." --- (SO, earning call, 2024/Q1)

"We also expect to maintain dividend growth that targets the low end of the 5% to 7 percent range, which reduces our external financing needs and provides us financial flexibility in the future. We're proud of our nearly 2 decade long streak of serving as clean energy leaders for our customers in the country while maintaining a premium investment for our shareholders." --- (XEL, AGM, 2024/05/22)

"An important part of our value proposition is a remarkable track record of our dividend. The Southern Company Board of Directors recently approved an $0.08 per share increase in our annual common dividend." --- (SO, AGM, 2024/05/22)

Changes in regulatory environment

Utility companies are experiencing a constructive regulatory environment, enabling capital deployment and growth (NEE). Proactive engagement in regulatory and legislative spaces is crucial due to industry dynamism (AEP). Regulatory recovery mechanisms and changes in rate base, capital structure, and ROE directly impact net earnings (EXC). Fair and constructive regulatory treatment is anticipated (DUK).

"You've got a great legislative environment, you've got a constructive regulatory environment, and you've got the growth that you need in order to deploy capital in the state." --- (NEE, Investor Day, 2024/06/11)

"We are making sure that we are getting those filled and we're adding additional resources in the regulatory and legislative space, because we know that as dynamic as our industry is and as much change as is occurring, we want to make sure that we have that enhanced engagement at those levels." --- (AEP, earning call, 2024/Q2)

"I think we have the experience, we have the wherewithal, we have these constructive regulatory environments, and we have the framework to do this, I think, in a way that makes sure that is orderly and disciplined and provides benefits to all stakeholders." --- (SO, earning call, 2024/Q2)

"For regulatory recovery mechanisms, including transmission formula rates and riders across the utilities, revenues increase and decrease i) as fully recoverable costs fluctuate (with no impact on net earnings), and ii) pursuant to changes in rate base, capital structure and ROE (which impact net earnings)." --- (EXC, press release, 2024/08/01)

"And if we do that well, we believe the company will be treated fairly and constructively in the regulatory environment." --- (DUK, earning call, 2024/Q2)

Market sentiment and investor behavior

Investor sentiment towards utility stocks is buoyed by companies' commitments to shareholder value, innovative compensation policies, high demand for nuclear energy, leadership in energy transformation, and data-driven technological advancements.

"And as we move forward in this exciting and evolving market, we will continue to remain anchored in those core principles, while we seek to deliver value for our shareholders." --- (NEE, Investor Day, 2024/06/11)

"This share this investor asks, why do we give shares to executives and directors, pay them and allow them to purchase shares at a reduced rate, 75 to 85 percent of the current price, and require them to hold the shares for a specified period of time depending on the discount." --- (DUK, AGM, 2024/05/09)

"The sentiment and demand for nuclear energy is at its highest in decades. We must ensure red tape does not prevent investment and innovation in new technologies." --- (AEP, Twitter, 2024/06/19)

"offers a unique opportunity for our jurisdictions to attract business in an exciting emerging industry, and we welcome supporting our customers in this work.Serving more customers than any other utility in some of the largest, most critical cities in the country, we are a leader in investing in the energy transformation and supporting economic development." --- (EXC, earning call, 2024/Q2)

"Our talent gains experience. Why? Because we move them across the organization, and we have experience in transmission and market knowledge that nobody else can match technology, which starts with our massive data advantage, which we have used to design tools that nobody else has, including generative AI tools that are transforming the way that we do business.Without the right data, there is no technology to leverage, and we have decades of data that we use across FPL and Energy Resources to make smart capital investments for our customers." --- (NEE, Investor Day, 2024/06/11)

Comparative analysis with other sectors

Utility stocks are positioned for stable growth and superior returns, particularly in renewables and infrastructure, compared to other sectors. Their role in economic development and strategic investments highlights their resilience and potential advantages during the Fed's easing cycle.

"As the largest transmission and distribution utility in the country by customer account, we are an integral partner to areas like Baltimore City for revitalization and economic development, addressing aging infrastructure challenges, the need for new development and electrification and the capacity constraints from increased load. At these two projects highlights, we are uniquely positioned to support our jurisdictions to meet load growth demands in an equitable manner, no matter where the load is located." --- (EXC, earning call, 2024/Q2)

"Index to Financial Statements MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Earnings for both the electricity and natural gas businesses are subject to a variety of other factors." --- (SO, sec filing, 2024/Q1)

"This paradigm shift towards simultaneous growth and transformation across our sector positions us well to keep making investments in renewables, storage, and transmission, where we expect to deploy capital not only to realize long term stable cash flows, but at superior returns and delivering adjusted earnings and adjusted earnings per share growth." --- (NEE, Investor Day, 2024/06/11)

"Calvin Butler: And the key to your question for me is that the utilities in all of our jurisdictions, we will be a partner in economic development, identifying areas and opportunities to put the assets of our jurisdictions in play." --- (EXC, earning call, 2024/Q1)

"Index to Financial Statements MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) The amount, type, and timing of any financings in 2024, as well as in subsequent years, will be contingent on investment opportunities and the Registrants' capital requirements and will depend upon prevailing market conditions, regulatory approvals (for certain of the Subsidiary Registrants), and other factors." --- (SO, sec filing, 2024/Q1)

See also