Shares of utilities NextEra Energy (NYSE: NEE), NextEra Partners (NYSE: NEP), Hawaii Electric (NYSE: HE), and Brookfield Renewable Corporation (NYSE: BEP) were rallying today, up 5.6%, 6.6%, 6.1%, and 8.6%, respectively, as of 3:22 p.m. ET.
These stocks have been beaten down this year in a rare volatile year for utilities, which are often seen as defensive stocks. Hawaii Electric had its own company-specific disaster after the fatal wildfires in Maui this summer and potential liability stemming from that. However, the entire utility sector — especially those companies with high exposure to renewable projects — has been especially depressed due to surging interest rates this year.
But this morning, the Bureau of Labor Statistics released October inflation data, showing a softer-than-expected reading. That could pave the way for lower interest rates, thereby reversing the massive rate headwinds investors have seen this year.
The October Consumer Price Index showed a 3.2% increase over the past year and was flat month over month. Both of those readings were below expectations, and marked a deceleration from the 3.7% year-over-year and 0.4% month-over-month increase in September.
Energy prices helped the decline in the CPI, but even on a “core” basis, stripping out volatile food and energy prices, inflation also came in lower than expected, at 4% year over year and 0.2% month over month.
Today’s lower inflation readings sparked enthusiasm that the Federal Reserve may be done raising interest rates, and may begin to lower them. That’s great news — although some investors believe that won’t happen without the U.S. enduring some sort of recession.
If a recession is the price to pay for lower inflation, utility stocks are still likely to benefit. This is because people don’t cut their power usage during a recession, and utility rates are usually fixed for a period of time — typically one year. Given ongoing grid hardening, distribution and transmission investments, and investments utilities are making in renewables, utility rates are likely to continue rising.
Lower interest rates are likely to especially help renewables-focused utilities like NextEra. This is because NextEra uses its yieldco NextEra Partners to buy projects from it, after which NextEra Energy recycles capital into new projects. As NextEra Partners pays out basically all its funds from operations as dividends to shareholders, it’s dependent on debt and equity markets to then acquire new projects.
But as interest rates rose violently this year, NextEra Partners’ stock fell, making it more dilutive to sell stock or debt in order to buy projects. That caused the model to become “stuck,” and therefore limited the flow of new projects.
However, lower interest rates could pave the way for a higher stock price, which would enable NextEra Partners to sell stock or raise debt and fund new projects, which could restart its growth flywheel again. NextEra Partners is still down by some 67% from its price to start the year, so it still has work to do. Still, today could be a promising start.
A similar dynamic played out with Brookfield Renewables, which invests in hydroelectric, wind, and solar projects. Brookfield is not exclusively dependent on capital markets as NextEra Partners is, as it sometimes recycles owned projects to raise cash to buy new ones, but it does also raise money from debt or equity markets to buy projects. Thus, it is also dependent on interest rates that affect not only valuation, but also its ability to buy more projects and grow.
Finally, Hawaii Electric is in some serious trouble following this summer’s wildfires. On its recent conference call, management noted it would not be able to file its quarterly filings on time, as the company has to deal with funding a new state fund to compensate victims, as well as defend itself in 64 other ongoing lawsuits.
Still, companies that are in trouble, or that have significant debt and may need to raise additional capital, would also benefit from lower interest rates. In fact, easing financial conditions could mean the difference between staying afloat and bankruptcy.
Warren Buffett once said, “Interest rates are to asset prices what gravity is to the apple.”
And while that is true of all assets, some stocks may not go up in a lower rate environment if the economy contracts and earnings go down. But utilities are usually recession resistant.
It’s still too soon to tell if the current bout of disinflation will lead to a “soft landing” with no recession, or if a recession will occur in the future. But in either scenario, utilities would benefit, which is why they are rocketing higher today.
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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends NextEra Energy. The Motley Fool recommends Brookfield Renewable Partners. The Motley Fool has a disclosure policy.
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