Even as investors have turned to utilities for yield amid still-low interest rates, there is another aspect helping the sector grow: clean energy.
As states set goals for reducing fossil fuel use, renewables like wind and solar have become what Gavin Tam, associate portfolio manager and analyst with Alpine Woods Capital Investors, sees as a secular growth trend in the space.
Now isn’t the best time for bargain hunting in utilities because they have outperformed this year, but Mike Bailey, director of research at FBB Capital Partners, says the sector is still attractive. And within the sector, it makes sense for investors to own both conventional-generation utilities, as well as some utilities with more renewable projects.
[See: 7 Ways to Tell if a Stock Is a Good Price.]
Generating growth. Renewables are helping some utilities create a portfolio of energy services beyond simply generation, such as energy storage and management directly to customers, says Rob Wilhite, managing director with Navigant.
“They’re finding growth outside of the regulated jurisdictions,” Wilhite says.
Many utilities may be pursuing renewables because they can generate new growth and more predictable returns than with fossil fuel generation, which require buying fuels, Bailey says. But renewables can have lower margins than utilities’ legacy business, he says.
Government incentives have also helped profitability.
Navigant sees utility-scale solar and wind systems gaining traction because of their cost efficiencies, Wilhite says.
One way for investors to gain exposure is to look to regulated utilities that can add renewables to their asset base and then earn a return on that investment by charging higher rates to customers, Tam says.
Another way is to invest in utilities with unregulated development businesses that build wind and solar assets and then charge for that electricity generated or, more often, sell the completed assets to other utilities or yieldcos, he says. Yieldcos are companies formed to buy stable, cash-producing assets, such as wind or solar farms, from companies engaging in riskier development work.
[See: 10 Best ETFs for Large-Cap Stock Growth.]
Factors for investors to weigh. In the near term, there hasn’t been a simple correlation between adding renewables and seeing profit margins grow because some utilities are more heavily regulated than others, and the extent they can recoup investments can depend on where they operate, Bailey says.
And as government incentives such as tax credits wane, company profits may be pressured, he says. However, that could be offset because of the improving costs of purchasing wind turbines and solar panels in bulk, he says.
If natural gas prices remain ultra low in the United States, utilities will be more reluctant to add more renewable generation, Bailey says. But if prices go up, that switch could accelerate, he says.
Also, regulators tend to allow renewables installation only at a measured pace as maturing technologies remain expensive, Tam says. And, of course, not every geography lends itself to wind or solar electricity generation.
[See: The 10 Best ETFs for Value Investors.]
Here are some companies to consider.
Duke Energy Corp. (ticker: DUK). Wilhite says Duke’s progress in adding renewable generation capacity in both regulated and nonregulated operations is noteworthy. From 2007 through 2015, Duke invested more than $4 billion in wind and solar projects in 12 states and plans to invest around $3 billion more over the next five years, the company says. Duke Energy Renewables, part of the company’s commercial portfolio, owns and operates 2,100 megawatts of wind power production and 400 megawatts of solar power production.
NextEra Energy (NEE). NextEra has made some of the most progress in adding renewable generation capacity in the industry, especially in wind, Wilhite says. And like Duke, this company has also been working to create a nonregulated portfolio. NextEra’s profit margins have benefited from the company’s exposure to renewable development projects, Bailey says. As of the end of last year, projects owned and/or operated by the company amounted to some 15 percent of the installed U.S. wind power production capacity and around 9 percent of utility scale solar capacity.
Xcel Energy (XEL). Xcel is a leader in adding renewables to its generation mix, Bailey says. The company also has been able to add wind generation to its asset base and successfully earn returns on that investment, Tam says. At the end of last year, Xcel had more than 6,500 megawatts of wind generation in its portfolio and more than 440 megawatts of solar power.
More from U.S. News
7 Ways to Tell if a Stock Is a Good Price
8 ETFs for Investors Who Love Value
9 Growth Funds That Will Turbocharge Your Portfolio
Utilities See Growth Potential in Renewables originally appeared on usnews.com
