The Federal Reserve increased interest rates once more this year by 0.25% to the range of 2.25-2.5%, marking the fourth hike in 2018. The primarily reasons behind the rate revision were ongoing strength in the U.S. economy, low and stable inflation, consistent job addition, unemployment rate falling to historical lows and an upward revision in wages.
The Fed rate has now been raised for the ninth time since the first hike was announced in December 2015 when the U.S. economy had pulled itself out of the Great Recession. The Fed kept interest rates near zero for seven years, in a bid to assist the economy to recover before increasing rates from December 2015.
Rate hikes are welcomed by some sectors like Banking, in anticipation of higher interest income. However, the capital intensive Utility sector might cringe at the thought of it, for it takes recourse to external sources of financing to meet its capital requirements. In a way, rising interest rates increase this sector’s cost of capital, in turn impacting margins. Plus, higher cost of funding could force the utilities to delay their capital expenditure plans, impacting cash flow and earnings growth. The rate hikes also comprise Utilities’ ability to consistently pay out dividend.
More Rate Hikes
Fed Chair Jerome Powell sounded cautious and reduced rate hike possibilities for 2019 to two from earlier expectation of three, with the U.S. GDP expected to improve 2.3% in 2019. The cautious approach takes into consideration the lower-than-expected development in global economy, uncertainty surrounding the U.S.-China trade dispute and impact on the global economy post U.K.’s exit from European Union.
Despite the present rate hike and expected rate hikes in the next two years, Fed rates will still be lower than the historic high of 5.25% touched in June 2006.
Banking on Utilities
Utilities are traditionally averse to interest rate hikes. However, the domestic-focused regulated utilities come up with stable performances quarter after quarter, as the demand for utility services hardly fluctuate with the vagaries of economy. We expect cost control, new electric rates and customer growth to help the utility sector to maintain operational stability.
Despite four interest rate hikes this year, S&P 500 Utilities have returned 1.1% in the past 12 months against S&P 500 group’s decline of 4.9%.
The qualifying criteria include a current ratio greater than 1, which indicates that a company has enough resources to pay its debts over the next 12 months. The utilities have a debt-to-capital ratio that is lower than the industry average. Moreover, their earnings estimates have also shown an upward revision in the past 60 days.
IDACORP, Inc. IDA is based in Boise, ID. This regulated utility is engaged in the transmission, distribution, and sale of electricity services in southern Idaho and eastern Oregon through its primary subsidiary Idaho Power Company. The long-term earnings growth of this utility is 2.78%.
This Zacks Rank #1 (Strong Buy) stock has a current ratio of 2.23 and a debt-to-capital ratio of 43.6%, lower than the industry average of 49.52%. IDACORP delivered positive earnings surprises in the last four quarters, with the average being 11.69%. Its earnings estimates for 2018 have increased 3.7% in the past 60 days. You can see the complete list of today’s Zacks #1 Rank stocks here.
Otter Tail Corporation OTTR is based in Fergus Falls, MN. The company, along with its subsidiaries, is engaged in electric, manufacturing, and plastics businesses in the United States.
This Zacks Rank #1 stock has a current ratio of 1.48 and a debt-to-capital ratio of 44.86%, which is lower than the industry average of 49.52%. Otter Tail pulled off average positive earnings surprise of 18.55% in the last four quarters. Its earnings estimates for 2018 have increased 2.5% in the past 60 days.
One Year Price Performance
Consolidated Water Co. CWCO, along with its subsidiaries, is involved in the development and operation of seawater desalination plants and water distribution systems in areas where naturally occurring supplies of potable water are scarce or nonexistent. The long-term earnings growth of this utility is pegged at 8%.
This Zacks Rank #2 (Buy) stock has a current ratio of 7.17 and a debt-to-capital ratio of 0.0% compared with the industry's average of 42.70%. Consolidated Water recorded average positive earnings surprise of 1.85% in the last four quarters. Its earnings estimates for 2018 have increased 29.8% in the past 60 days.
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