The utilities sector and ETFs, such as the Utilities Select Sector SPDR (NYSEArca: XLU), haven’t lived up to their defensive reputation amid the COVID-19 pandemic, but recent weakness in the group has made valuations a bit more reasonable.
Defensive utilities are typically more stable stocks since the demand for their services, notably electricity and gas, is steady from both consumers and businesses. Moreover, in a lower-for-longer yield environment, utilities come with more attractive above-average dividends.
“We think this downturn opens long-awaited buying opportunities, especially for defensive investors. Most utilities are financially strong with attractive growth potential and historically high dividend yields relative to interest rates,” said Morningstar in a recent note. “We do not plan any significant fair value or moat rating changes based on coronavirus impacts.”
Valuations More Tolerable
The research firm said that, by its estimate, the broader utilities sector is now 7% undervalued, something of a rarity among an often richly valued sector.
“Before the downturn, we were among the few who thought utilities valuations were far too rich. U.S. utilities peaked at 21% overvalued in mid-February based on our fair value estimates. The sector is down 24% since then,” according to Morningstar.
The defensive and yield-generating utilities play is garnering greater attention as a growing number of people are looking to global central banks, including the Fed, to lose monetary policies and execute accommodative measures to obviate a potential economic downturn in response to a coronavirus outbreak.
Utilities are typically more stable stocks since the demand for their services, notably electricity and gas, is steady from both consumers and businesses. Moreover, in a lower-for-longer yield environment, utilities come with more attractive above-average dividends.
Utilities stocks hold some allure for investors because the sector generates nearly all of its revenue on a domestic basis. S&P 500 utilities companies, on average, depending on the U.S. for 95% of their revenue.
“Utilities’ 3.3% average dividend yield is more attractive than it has been in at least 40 years relative to interest rates. Investors now get 260 basis points of yield premium to the 10-year U.S. Treasury rate, nearly matching the all-time high premium in mid-2012,” according to Morningstar.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.