Capitalizing on Utility Stocks: A Strategic Move Amid Falling Interest Rates

Exploring Utility Stocks: A Wise Investment Amid Lower Interest Rates

The S&P 500 index offers a modest dividend yield of 1.3%. In contrast, utilities, represented by the Utilities Select Sector SPDR Fund with a 0.45% yield, provide an average yield of about 2.9%. This is more than double the average yield of S&P 500 stocks, making utilities an attractive option for those seeking dividend stocks.

Utilities often depend on borrowing as part of their business strategy, and changes in interest rates can significantly impact their operations. Recently, the Federal Reserve reduced the fed funds rate and indicated potential further cuts, suggesting that borrowing costs for banks might decrease in the coming years. This situation bodes well for dividend-reliant stocks. Below are three promising utility stocks that stand to benefit from these monetary policy shifts.

1. NextEra Energy: A Dividend Growth Powerhouse

NextEra Energy, with a dividend yield of 2.4%, falls below the utility average, which might deter some investors at first glance. However, the real allure of NextEra lies in its impressive dividend growth. Over the past three decades, the company has consistently raised its dividends, with an average annualized increase of 10% in the last ten years. This includes a consistent 10% increase over the one-, three-, and five-year spans, underscoring its reliability in dividend growth.

A 10% growth rate is commendable for any company, and even half of that rate is considered strong for a utility. NextEra’s growth is driven by its diverse asset portfolio, which includes a regulated utility operation in Florida—a state experiencing steady population growth—and one of the world’s largest solar and wind energy companies. This clean energy investment represents both a historical and future growth opportunity as the world transitions to cleaner energy solutions.

With lower interest rates, NextEra can afford the capital investments necessary to expand its clean energy assets. For dividend growth investors, NextEra Energy is worth revisiting in light of the Fed’s recent rate adjustments.

2. Dominion Energy: Navigating a Turnaround

Dominion Energy has recently been downsizing, notably selling three natural gas utilities to Canada’s Enbridge. The proceeds from these sales have been utilized to strengthen Dominion’s balance sheet.

Utilities typically own costly assets that, due to regulatory oversight and regional monopolies, generate stable cash flows. Consequently, they often leverage heavily. However, sometimes debt levels can exceed optimal thresholds. For Dominion, selling assets has been a strategic move to quickly reduce leverage.

The Federal Reserve’s rate cuts are expected to aid Dominion in its deleveraging efforts. Although a 50 basis point reduction might seem minor, with Dominion’s $32.6 billion debt, every basis point matters. The benefits will initially appear in revolving credit facilities, eventually lowering refinancing costs.

Dominion’s 4.6% dividend yield stands out, partly due to its turnaround status. Despite this, it remains a relatively low-risk investment, and the ongoing turnaround has become slightly easier with the recent rate cuts.

3. Black Hills: The Steady Dividend King

Black Hills, a smaller utility with a market cap of $4.2 billion, boasts a 4.2% dividend yield. This yield is particularly attractive given Black Hills’ status as a Dividend King, having increased its dividend annually for 54 consecutive years. Few utilities can claim such consistency, making Black Hills a top choice for those focused on dividend reliability.

Over the past decade, Black Hills’ dividend has grown at an annualized rate of 5%. While this is only half of NextEra Energy’s growth rate, it remains a solid figure for a stable dividend grower. Black Hills does maintain more leverage than other utilities, which means rising interest rates can affect it more severely. However, with falling rates, Black Hills will find managing interest expenses easier.

Unlike Dominion, Black Hills isn’t in the midst of a turnaround. It is simply a well-managed utility continuing its successful operations. If steady performance appeals to you, now might be the right time to consider adding Black Hills to your portfolio, as declining rates enhance its appeal.

Conclusion: Lower Rates Enhance Utility Appeal

NextEra Energy, Dominion Energy, and Black Hills are not the only utilities set to benefit from declining interest rates, but they exemplify diverse investment approaches: from dividend growth to turnaround stories, to stable dividend producers. The shift toward lower interest rates makes all three attractive investment options.

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See 3 “Double Down” stocks ›

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