Utility stocks take a beating amid rising rates

Utility stocks took a breather on Tuesday following the sector’s worst daily performance since April 2020.

The SPDR S&P 500 Utility Sector ETF (XLU) fell 4% on Monday and recovered to end the next day higher. Year to date the ETF is down a whopping 21%.

Much of the damage on the normally “safe-haven” area of the market has to do with higher rates.

Stocks for companies that range from electricity providers to water suppliers normally offer dividends. But those payouts don’t look as appealing to investors when compared to soaring bond yields in a tight monetary policy environment. On Tuesday, the two-year Treasury note hovered around 5.15% while the 10-year touched 4.79%.

“Many utilities currently offer forward yields near 5%. However, when investors can obtain risk-free Treasuries offering yields between 4.5% to 5.5%, depending on the maturity, the risk-reward trade off for holding utilities is much less attractive, “ equity analyst Daniel Rich at CFRA Research told Yahoo Finance.

STANISLAUS COUNTY, CALIFORNIA - MAY 19: California Governor Gavin Newsom (R), former Mayor Antonio Villaraigosa (C), and Jim Shandalov, Vice President at NextEra Energy Resources walk along the construction of the Battery Energy Storage Systems (BESS) for the future site of Proxima Solar Farm on May 19, 2023 in Stanislaus County, California. The Governor unveiled legislation to speed up construction for a streamlined process and to expedite court review on legal challenges that often tie up projects. The project is expected to create 300 construction jobs and generate $35 million in local revenue. The project is expected to be operational by December, could power 60,000 homes in the surrounding region and can generate up to 210 megawatts of clean, renewable energy and 177 megawatts of better energy storage. (Photo by John G. Mabanglo-Pool/Getty Images)

Jim Shandalov, vice president at NextEra Energy Resources, California Governor Gavin Newsom (R), and former Mayor of Los Angeles Antonio Villaraigosa (C) walk along the construction of the battery storage facility for a solar farm. (John G. Mabanglo-Pool/Getty Images)

Additionally, the Federal Reserve’s interest rate mantra of “higher for longer” also means the cost of capital will stay elevated, another reason why the sector sold off aggressively last quarter. The market expects investments for new power plants, aging infrastructures, and renewable technologies will cost more.

Utility stocks were already in a downward trend since the start of the year as investors rotated into growth names. But the selling intensified last week when NextEra Energy Partners (NEP), a subsidiary of NextEra Energy (NEE) focused on renewables, cut its growth target by half to 6%, through at least 2026.

“Tighter monetary policy and higher interest rates obviously affect the financing needed to grow distributions at 12%,” read the company statement.

Some of the worst performers in the utility sector year to date include NextEra Energy, AES Corp (AES), and Eversource Energy (ES), down 52%, 37%, and 33% respectively.

“While the sector is very out of favor, we think the sell-off presents some attractive buying opportunities for names with competitive earnings and dividend growth potential,” said CFRA’s Rich.

“Among some of the larger names, we maintain Buy opinions on NextEra, Duke Energy (DUK), and American Electric Power (AEP),” he added.

Ines Ferre is a senior business reporter for Yahoo Finance. Follow her on Twitter at @ines_ferre.

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