You've Been Warned: Utility Stocks Facing Troubles
August 08, 2014
Utility stocks are practically screaming for some profit taking/rotation out of.
Unsuspecting investors (read: blind-faith yield chasers) may be slow to pick up on what has been happening of late. Consider this a chance to trim before other investors realize what is happening and decide to head for the exits as well.
Anyone just looking at quarterly returns is under the impression the utilities sector is doing just fine. Very fine . . . as seen in this stock chart showing the first half returns for the two largest utility ETFs: Utilities Select SPDR Sector ( XLU) and Vanguard Utilities ( VPU) alongside the equal-weight performance of the S&P 500 utilities sector:
But the past five weeks have seen a U-turn, as utility stocks have slid more than twice as much as the broad S&P 500:
XLU Total Return Price data by YCharts
Those losses over the five weeks are more than double the 12-month yield for both ETFs.
And this doesn't stack up as a buy-on-the-dip proposition. The good news for the U.S. economy, over the past few weeks, signals a push into the economic mid-cycle expansion phase. That's typically a period when accelerating growth and rising interest rates leaves utilities lagging the market. If we in fact see the 10-year Treasury make its way back to 3% or so by year end, then the 3.5% or so yields on these ETFs looks a whole lot less compelling given the equity risk.
And even with the recent slide, utilities are nowhere near bargain territory. Morningstar's ( MORN) proprietary fair-value ranking reports that the sector as of August 5th was trading at a 4% premium to fair value. While that's down from a 9% premium in late July it is nonetheless an above-market premium. Morningstar puts the overall market at about even with fair value right now. (Full disclosure: Morningstar is an investor in YCharts).
Nor is there a compelling growth story to be had. S&P Capital IQ estimates the S&P 500's utility sector will generate 7% growth in operating earnings this year and 2.5% in 2015, compared to 8.4% and 11.7% for the overall S&P 500 index. Meanwhile the sector's PE ratio of 15.8, based on 2014 estimates, is about even with the 16.2 for the S&P 500. And looking at 2015 expectations, the 15.4 PE for the utility sector is higher than the 14.5 estimate for the S&P 500. One more metric to chew on: The PEG ratio for the S&P 500's utility sector is 3.3x. That's more than double the 1.4x for the entire index, and around a 50% premium to the sector's PEG ratio prior to the financial crisis.
Just take a look at the five largest positions in the SPDR ETF. Duke Energy ( DUK) NextEra Energy ( NEE) Dominion Resources ( D), Southern Co. ( SO) won't be mistaken for values. Only Exelon ( EXC), but it committed the mortal sin -- at least for income investors -- of cutting its dividend last year.
DUK PE Ratio (TTM) data by YCharts
And it's not as if you have to necessarily give up yield to find a better valuation proposition. The same economic forces (growth) that are now expected to work against defensive utilities should be a tailwind for the cyclical energy sector. As this YCharts Stock Screener shows, dividend yields at or above the 3.5% range coupled with lower PE ratios are not exactly hard to find.
Chevron ( CVX), Royal Dutch Shell ( RDS.B), Total ( TOT) and Conoco Phillips ( COP) certainly delivery utility-matching yields:
CVX Dividend Yield (TTM) data by YCharts
Without the pricey-ness: 
CVX PE Ratio (TTM) data by YCharts
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.
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