MIZUHO SECURITIES USA INC. | US EQUITY RESEARCH
Summary
Investors are focused on the possibility of a December 16 Fed rate hike and if rates will continue to rise. Not surprisingly, utility investors are on the sidelines. However, we think the broader macro issues should garner more attention and a further analysis suggests the macro environment is not robust as some might think. That would argue for a defensive bent. And with utes trading at reasonable valuations, we think there is still room for the sector to do well into year-end and beyond.
Key Points
The utility sector continues to look appealing, in our view, and the markets appear to have priced in a 25 bps hike. Following the Nov 6 market correction when several Fed Governors suggested a December hike was forthcoming, the utes have rallied, outperforming the S&P 500 by 200 basis points. Mizuho's Chief US Economist, Steve Ricchiuto, has been spot on over the course of the year with his call regarding Fed action. Importantly, he believes the data still doesn't support a Fed hike at this time.
Macro data suggests challenges ahead and investors should seek a defensive bias. On Dec 1, the Atlanta Fed slashed 4Q15 GDP growth to 1.4% from 1.8% (Consensus: 2.5% growth). S&P 500 estimates are beginning to roll over, operating margins are declining, and U.S. and global GDP expectations are falling. Further, durable goods and retail sales are stumbling, commodity prices falling, and industrial production hurting. And that's just the start . . .
All of this belies the popular notion that utilities may retreat in the near- term. With most companies in the broader utility sector projecting 4-6% earnings growth and paying a roughly 4.0% yield, total return potential of approximately 8-10% is attractive, especially since one does not need to go out on the risk curve to produce such returns.
We remain positively biased with Buy recommendations on AEP, NEE, PCG, and WEC and while there isn't enough upside to warrant a Buy recommendation, we think ED, EIX, and ES are worth a look. Mega-caps DUK and SO will be turned to given their liquidity, but caution that both have their various 'puts' and 'takes' that investors need to remain cognizant of.
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