Utilities rebound as rates fall

Utility and infrastructure stocks lag the broader stock market when interest rates are rising, but they have a better time when rates start to fall.

With three rate cuts in Canada since June, that time is now. Another lift is coming from south of the border where Jerome Powell, who heads the US Federal Reserve, has indicated cuts are coming there.

The TSX Utilities Capped Index (TSX:TUTT) has fared poorly over the last three years, falling 18% from its 2021 high. But within the last three months – coinciding with the first Canadian rate cut in June – the index has moved higher by 14% at the time of writing. 

The sector suffers in a high rate environment because the cost of servicing corporate debt rises. Building pipelines, 5G networks, or electricity transmission lines is expensive and takes a long time to complete. So, the impact on a utility’s operations is huge. Their dividends also become less attractive relative to bonds and other fixed-income options such as guaranteed investment certificates (GICs).

My view is that utility stocks are buy and hold parts of income-oriented portfolios. The market rises and falls with the economy, but these companies deliver all the time. Sell if you want to rebalance your portfolio. Buy more if they are cheap. Enjoy the dividends along the way.   

A few of the more conservative Canadian utilities include: AltaGas (TSX: ALA), BCE (TSX: BCE), Emera (TSX: EMA), Enbridge (TSX: ENB); Fortis (TSX: FTS), Hydro One (TSX: H), Telus (TSX: T), and TC Energy (TSX: TRP).

The average yield of this group is a handsome 5.6%. The lowest dividend yield is Hydro One at 2.6%. But Hydro One has delivered in other ways. While the dividend isn’t the best, its shares have hit a series of new highs. At the current price, the shares are up 20% this year compared with 13% for the TSX.

The highest yield in the group is BCE at 8.5% at the current price. BCE has struggled with high rates, but in addition worries persist about its outlook and ability to keep increasing its dividend. BCE has responded with cost-cutting and reductions in capital spending.

Beyond individual stock picking, investors can also look at utility ETFs. There are quite a few with many variations. Some are broad, others more targeted by sub-sector. They also come in many geographic varieties.

Here are some variations:

The all-Canadian Hamilton ETFs Utilities Yield Maximizer Fund (TSX: UMAX) holds 13 high dividend-paying utility, telecom, and pipeline companies. It employs an active covered call strategy to improve yield, which sits at a high 13.93%. The distributions are monthly. The fund has a high management expense ratio of 0.65% and a limited track record as it was launched last year. It has $340 million in assets and a 1-year return of 7.88%.

The globally positioned Harvest ETFs Equal Weight Global Utilities ETF (TSX: HUTL) holds an equally weighted portfolio of 30 companies. About 41% are in the US and 17.5% in Canada. It includes many of the same sectors as the Hamilton fund and also uses a covered call strategy. It has a current yield of 8.38% and $229 million in assets. It also offers monthly distributions and was launched in 2019. It has a lower MER of 0.50% and a 1-year return of 7.4%.

An all-US option is the Vanguard Utilities ETF (NYSE: VPU), which holds 66 stocks. Almost two-thirds of the holdings are electric utilities. It has US$6.4 billion in assets, was launched 20 years ago, and a low MER of 0.10%. Morningstar Research notes that this low cost is a relative advantage over other funds in its group. It has a 1-year return of 25.3%.

As always, investors should take a closer look at the funds and discuss their suitability with an advisor.

This article appeared in a recent issue of the Income Investor.  For information on how to reprint this article please view this page.