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  Insights

Utilities
Utility stocks may be fueled for a bright future

Historically, utility stocks haven’t been known as high wattage. They have been prized by income-oriented and risk-averse investors for their generally lower risks, steady results, solid dividends and comparative resilience relative to other sectors. The trade-off has been modest earnings growth and price gains, especially in comparison with the electrifying advances notched by some other sectors in recent years.


However, two significant and interlocking developments are slowly transforming American society: the shift from fossil fuels to renewable energy and the mainstream embrace of electric vehicles, or EVs. Both could spark impressive long-term growth for utility companies, explains Capital Group equity analyst Andre Meade.


Electric vehicles are projected to use much more energy in the coming decades

Alt text: Annual U.S. electric vehicle energy demand, 2021 vs projections for 2030 (in terawatt-hours). In 2021, buses used 0.1 terawatt-hours of energy; they're projected to use 8 in 2030. Trucks used 0.1 but are projected to use 23, light commercial vehicles used 0.2 but are projected to use 33, and passenger cars used 10.8 but are projected to use 167. As of April 2022. Source: Statista.
Source: Statista. As of April 2022.

The clean energy push will require considerable infrastructure spending. The transition to renewables will force system upgrades to accommodate and adapt to wind and solar power. In particular, the expected surge in electric cars will require enormous outlays to generate sufficient electricity for the new generation of vehicles.


For most industries, heavy investment to produce and deliver a product for a new set of customers would be a challenge. Not so in the highly regulated utility business, where capital expenditures are the primary driver of profits. Utility regulation allows for a return on investment, and fuel, operations and maintenance expenses are passed on to customers without a markup.


Accordingly, if capital investments can help lower fuel and maintenance costs, then utility profits will rise and customer bills will remain low. This win-win scenario is the case with renewables, while the new demand from EVs should  help utilities spread their fixed costs and put downward pressure on bills.


The pace of renewable energy and EV adoption is not certain, although the direction is clear. There are permit and supply chain challenges for renewables, and these intermittent resources present reliability challenges for utilities and regulators. Wind and solar resources vary geographically, limiting where these facilities can and should be built. As well, forecasts of EV sales could be incorrect, and the geographic clustering of electric cars means demand could be highly localized.


Nevertheless, the energy transition may have reached a self-perpetuating inflection point that could endure for decades, Meade believes. The U.S. Energy Department estimates that increased demand across all sectors could boost nationwide electricity use 38% by 2050. That would require the government and utility companies to stay the course with massive investment.


“I think we have several decades of above-average growth ahead,” Meade adds. “I think the utility sector’s rapid growth will surprise many in the coming years. It has a relatively low-risk business model and generally higher yield than the rest of the market, to boot.”


Electric vehicles could supercharge utilities.


Thanks partly to conservation efforts and the improved efficiency of televisions and home appliances, U.S. electricity consumption has been flat for 15 years. EVs could change that. A general rule of thumb holds that as few as two EVs gobble as much annual electricity as a single-family home.


A two-car household that went electric could conceivably double its power usage.


Despite uncertainty over long-term EV penetration rates, several factors — rising consumer acceptance, elevated gas prices and manufacturers’ willingness to put these vehicles at the forefront of their product lineups — suggest a turning point.


Today, U.S. EV market share is less than 1%. That’s expected to increase to 8% by 2030 and to a whopping 42% by 2040, according to Bloomberg. That means anywhere from 18 million to 82 million EVs on the road. The number of models is expected to leap to 100 from about 30 today.


“EVs are the Holy Grail for utilities,” Meade says. “Every EV out there is an energy market share shift to utilities from the oil and gas industry. Utilities that are all electric in states with faster EV adoption, lots of commuting and poor public transport may benefit the most.”


The EV story is a long-term one, with the greatest impact likely to come after 2030 as electric cars slowly catch on nationwide, he adds.


The recently enacted Inflation Reduction Act, which earmarks $369 billion in spending to motivate consumers and accelerate the transfer to clean energy, could be an additional propellant.


“There is potentially a 20- to 40-year tailwind for utilities taking market share from oil,” Meade says.


Growth could also come from the development of EV charging stations, a large new area of investment that utilities would help build.


Beyond the EV phenomenon, other factors could drive infrastructure spending. Older, less efficient power facilities such as coal plants are slowly being phased out in favor of newer facilities or clean energy substitutes. “Just swapping out older, heavily depreciated coal plants for renewables has been an earnings driver,” Meade notes.


Utilities are likely to retain their traditional defensive characteristics.


Some of the historical selling points for utilities, including their comparative resilience in troubled economies as regulated monopolies selling an essential product, should remain going forward. Consumers may cut back on usage during trying times, but they don’t eliminate electricity or heating altogether.


“These characteristics lead to a relatively low-risk business model and the ability to pay attractive dividends,” Meade explains. “Growth is rising, and I believe this growth will hold up well even during periods of economic weakness. In short, I like the utilities sector, both short term and long term.”



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