Utilities ETFs, including the Utilities Select Sector SPDR (NYSEArca: XLU), are performing admirably this year. Low bond yields and investors’ desire for defensive assets in the wake of the coronavirus are helping the cause, but there may be more to the story.
Momentum continues building for renewable energy over coal and that’s not hurting electric utilities, such as those residing in XLU. That transformation is actually seen benefiting traditional utilities, which are adapting to shifts in the electricity generating landscape.
“Morgan Stanley & Co. LLC sees a $64 billion spending opportunity on top of double-digit earnings accretion for more than a dozen utilities that decide to retire uneconomic coal plants and replace them with cheaper renewables by 2025,” according to S&P Global Market Intelligence.
Utilities are typically seen as a defensive sector or a more steady area of the market to ride out the volatility. These companies typically offer the most fundamental necessities, such as food, water, and shelter, or are closely related to the energy required to refrigerate food, heat up water and light up a house.
Legitimate Benefits
“We compared the costs of operating each coal plant against our state-by-state forecasts of renewables costs across 13 stocks and identified [47,000 MW] of coal capacity that will become more expensive than renewables by 2024,” said Morgan Stanley. “We estimate this represents a capex opportunity of [$64 billion] and earnings accretion for the stocks we cover of up to 14% in 2025.”
Ameren Corp., American Electric Power Co. Inc., Duke Energy Corp. and Pinnacle West Capital Corp. – stocks that combine for over 16% of XLU’s weight “are seen as best positioned to take advantage of a second wave of clean energy,” notes S&P Global Market Intelligence.
The utilities sector was also one of last year’s best-performing areas, underscoring the notion that many investors will embrace utilities and related ETFs during favorable interest rate environments after the Federal Reserve cut interest rates three times.
Related: Defensive Utilities ETFs Have Been a Great Play so Far This Year
The sector also provides a steady dividend, providing investors with a bond-esque income return. Furthermore, in a lower-for-longer interest rate environment, the yields on utilities makes them that much more attractive to income-minded investors.
Morgan Stanley notes that each dollar saved by a utilities provider when shuttering a coal-fired plant could lead to $7 to $8 to spend on renewable projects.
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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.