Are UTILITIES Mutual Funds/ETFs a good buy now, or not??

[bizman]

Mar 27, 2022 14:18:13 GMT @skip said:

Many of these utilities seem to have reasonable payout ratios, but when you look at their cash flow statements, free cash flow (I just do operating cash flow less capital expenditures) is frequently negative, and the cash for dividend payments is typically generated through debt/equity issuances. Such dividends might be costly to maintain going forward.

I'm really not looking to become the board's apologist for utilities.  They can perform badly, both in terms of management in operations and stock wise, especially if they have hostile regulators and/or politicians.  Plus higher interest rates are a big headwind to earnings, as well as valuation multiples.  These things are always risks.  And I would certainly not endorse all utilities.

And I'm a fairly simple guy, not a CFA, who largely relies on the analysis of others to form my overall view:  M*, Value Line, and others.

At the same time, I believe the business model of utilities is rather unique.  They have an efficient scale moat that allows them freedom from competition, but limits their returns to something reasonable but not egregious (say around a 10% ROE).  Poor operations or other bad management behavior and judgment can destroy value.  Dividends can be cut.  Even regulated utilities have been known to perform poorly.

One of the most important things for a utility is to maintain an investment grade balance sheet.  This is something both management and regulators focus on, at least if they want the utility to be able to access the markets to fund growth projects at reasonable costs.  They don't fund growth out of organic cash flow.  They fund it out of new debt and equity based on a guaranteed ROE allowed by their regulators.

If the numbers don't pencil out, the growth projects don't get funded and don't get done, at least in a very general sense.  Of course, a ute could go into a kind of death spiral where they are increasingly unable to meet their dividend, let alone grow it, and could have to chop it to go into survival mode.

But investors aren't potted plants, and should be able to gauge whether management is heading in a bad direction or not.  To me, the first indicator is slowing or no dividend growth.  It is not impossible, but certainly rather unlikely that a ute will increase it's dividend by 6% a year for quite a while and then turn around and cut it (although something like that did occur with Dominion Energy when they sold their midstream biz to Berkshire Hathaway and did a "reset" to their dividend).  Which is why I tend to favor something more like AEP that has pretty nice growth. 

Also, listening to conference calls, and following analyst commentary should give one a fair idea of those in trouble and those not.  

But the bigger thing I think of is that if the gov't and regulators want to fund this massive buildout of renewables and new generation needed both for the Climate Change narrative, as well as switching the entire transportation sector from oil and gas to being plugged into the grid to power it over the next 15 years or so, massive investment will be needed.  Which will require massive debt and equity issuance and attractive ROEs to make the numbers work.  It seems, at least while elites want this massive investment, they will want to make the balance sheets and performance of the Utes be attractive enough to attract that capital at a reasonable price.

Now Liz Warren and Bernie Sanders could try to be hostile to utility companies while demanding they invest hundreds of billions of dollars to fund their policy priorities, but it seems to me this would be a hard trick to pull off.  Plus, investors would have a pretty good heads up of what was coming down the pike and could adjust their portfolios accordingly.

At the same time, Utes are not particularly attractive now.  Potential higher rates are a negative.  There are no guarantees.  Invest at your own risk.

[Deleted]

"But investors aren't potted plants, and should be able to gauge whether management is heading in a bad direction or not"

It is not that easy. I remember in 2008, Dodge and Cox - many companies in their top 10 disappeared from face of earth. And their letter said = Ohh we were in touch with the management and talked to them last week and they never mentioned any problems.

So if such venerable investors could not detect problems...

[bizman]

Mar 27, 2022 18:03:19 GMT @waffle said:

"But investors aren't potted plants, and should be able to gauge whether management is heading in a bad direction or not"

It is not that easy. I remember in 2008, Dodge and Cox - many companies in their top 10 disappeared from face of earth. And their letter said = Ohh we were in touch with the management and talked to them last week and they never mentioned any problems.

So if such venerable investors could not detect problems...

You are pointing out that investing in individual stocks is risky.  You are correct.  It isn't for everyone.

Plus you seem to think I am advocating for investing in individual utility stocks.  I am not.  I was trying to add to the discussion by explaining my understanding of the lay of the land.

You also missed part of my message when you were quoting me.  I usually hesitate to quote myself, but I'll make an exception in this case.

"Utes are not particularly attractive now. Potential higher rates are a negative. There are no guarantees. Invest at your own risk."

I'm sorry if a fairly fulsome discussion of a sector offends you.  There are no sure things I know of.  

Do you have some recommendations of riskless opportunities for the folks on the board to consider?  I'd love to hear some.

[retiredat48]

Mar 26, 2022 11:09:58 GMT @slooow said:

Edit - 8% inflation and Visa as a comparison for utility stocks.  If inflation stays at 8% for the long term - and I highly doubt that - that would not bode well for Visa either. Discretionary spending will slowly choke. Wages won't keep up at that pace.  Even without higher inflation - let's say 3% - I don't know how stable Visa earnings are, but I do know it has a tiny dividend yield. It's a growth stock. It has its role in a portfolio, but not for dependable income. 

My bold added above.  I consider that wages will keep up, at least for a few years.

This is because a lot of the increase is not due to business forces.  Rather, it is by government fiat.  Many regions have mandated wage increases. 

Like, it is little known but in my state, Florida, the people voted in a constitutional amendment that increases the minimum wage from below $10, to $15/hour by 2025...in a straight line.  That is a huge percentage annual increase...and expect the effects of this to reverberate through all worker wages.

So, we'll pay McDonalds workers $15/hr, and big macs will cost $15.  

I invested during the 1970's inflation.  One thing I see different is that business today have QUICKLY started raising prices; in the 70's the White House was pleading with business to hold back on increases.  It took awhile for end-user prices to get going.

R48

[retiredat48]

bizman ,...nice set of posts...Thanks.

To me, the next 2-3 months will be most telling regarding how high interest rates go, which compete with Utilities (as you and I both stated) for investor investment  For we will have:

1) "catch-up" in inflation due to oil/gas price rises, catchup in "rent-equivalent changes" for housing inflation, and catchup in wages...and:

2)  This is the first time in history the fed is ending direct support of various bonds, AND will start to reduce its balance sheet of same by billions and billions (called trillions!).  Will there be a massive impact on interest rates, and people doing a "flight to stocks?"  Or is all this really priced in already?

So far, the recent zooming-up ten yr treasury rate is suggesting a higher rate/yield than many have forecast.  Really surprised at the 30 year mortgage rate quick rise.
 
R48

[bizman]

Mar 27, 2022 23:07:48 GMT retiredat48 said:

bizman ,...nice set of posts...Thanks.

To me, the next 2-3 months will be most telling regarding how high interest rates go, which compete with Utilities (as you and I both stated) for investor investment  For we will have:

1) "catch-up" in inflation due to oil/gas price rises, catchup in "rent-equivalent changes" for housing inflation, and catchup in wages...and:

2)  This is the first time in history the fed is ending direct support of various bonds, AND will start to reduce its balance sheet of same by billions and billions (called trillions!).  Will there be a massive impact on interest rates, and people doing a "flight to stocks?"  Or is all this really priced in already?

So far, the recent zooming-up ten yr treasury rate is suggesting a higher rate/yield than many have forecast.  Really surprised at the 30 year mortgage rate quick rise.
 
R48

retiredat48, 

I'm with you on the big risk being much higher rates to match the inflation.  For all of my bloviating above, the real information in my posts as I see it is that I have moved from a 30% allocation to 10%.  The only reasons I have not gone to zero are that I'm not sure I'm aware of a vastly better alternative that I'm not already full up in, and I've got tons of cash at the moment.  As Howard Marks says, all judgments in investing are relative judgments.  That and that I'm heavy in cyclicals, and Utes at least tend to act as ballast on risk off days, at least mostly, and so far.

Plus, there is an alternative path, where we get a growth scare or God forbid, an actual recession, that at least temporarily derails huge upward rate moves.  I've found that when I tempt the investment gods with all or nothing moves, they tend to teach me a lesson, at least in the short run.  So I've tried to break myself of the tendency of thinking in terms of all in or all out.  

And hopefully the world situation works itself out reasonably well too.  Heck of a wildcard there.  Talk about inflation, with all ag inputs skyrocketing, Russian products boycotted, and Ukrainian farmers likely unable to plant (and if they can, can they harvest and ship?) we could have food shortages in the third world, and much higher prices everywhere.  Good luck to us all.  We will likely need it.

[retiredat48]

On another thread, Yogib posted:  "And what are Utilities smoking? Rising in the face of higher expected rates? Normally, strength in utilities means lower rates ahead, but that doesn't make sense."

Sara also replied:  Utilities are too high for me now.

-------------------------------------------
Yes, utilities had a rally recently with commentators stating it was "defensive buys."

It's always been strange to me, if I consider the market will fall,  and if I sell something, or make new investments, why should I buy something that will fall lesser...ie be defensive?  Just stay in cash or short term bonds.

Nonetheless, utilities have this feature of being "defensive".  But to Yogi's and Sara's point, the fundamentals really clash in that, the more utilities go up in price, the more the current yield is LOWERED.  And this has to compete with rising rates on the bond side--swiftly rising rates.  Something's gotta give in the long run.

So a long term investor has to compare any utility/fund being bought, against a fund like SCHD, with a SEC yield of just above 3%, or a short term 2 yr bond fund with a yield of 2.4% or more.

I vote SCHD and 2 yr bond funds.

R48

[Deleted]

Apr 4, 2022 15:21:35 GMT retiredat48 said:

On another thread, Yogib posted:  "And what are Utilities smoking? Rising in the face of higher expected rates? Normally, strength in utilities means lower rates ahead, but that doesn't make sense."

Sara also replied:  Utilities are too high for me now.

-------------------------------------------
Yes, utilities had a rally recently with commentators stating it was "defensive buys."

It's always been strange to me, if I consider the market will fall,  and if I sell something, or make new investments, why should I buy something that will fall lesser...ie be defensive?  Just stay in cash or short term bonds.

Nonetheless, utilities have this feature of being "defensive".  But to Yogi's and Sara's point, the fundamentals really clash in that, the more utilities go up in price, the more the current yield is LOWERED.  And this has to compete with rising rates on the bond side--swiftly rising rates.  Something's gotta give in the long run.

So a long term investor has to compare any utility/fund being bought, against a fund like SCHD, with a SEC yield of just above 3%, or a short term 2 yr bond fund with a yield of 2.4% or more.

I vote SCHD and 2 yr bond funds.

R48

The thought of buying bonds at negative real rates doesn't make sense to me.  Utilities are just part of a portfolio and would be a good supplement to SCHD if purchased at a fair price. They are currently inflated.  I would not buy any of the 3 today. 

[bizman]

Yeah, it's really a strange time and utilities don't seem to represent much value at these prices.

Larry Lindsey, former Fed governor, was just interviewed by Kelly Evans on CNBC and talked about how, in his opinion, with an 8% inflation rate and a .38% Fed Funds rate, we are in the middle of a wage price spiral. He thinks inflation never has gotten under control until Fed Funds is above the inflation rate, so that rates need to go much higher. He also implies that 3% Fed Funds won't be even close to fixing inflation.

He also thinks we are about to go into recession (this quarter I think he said) and that it will be caused by inflation, and consumers inability to deal with it, not so much the FF rate increases esp. since they act with a long and variable lag. Kind of a schizophrenic take, but these are schizophrenic times.

So this just illustrates the crazy cross currents we are dealing with. If he is even close to right on the recession call, that may explain the fact that Utes have caught a bid recently. But who knows.

[Deleted]

Buying based on value is what makes sense to me right now. And there isn't a lot of value out there. I looked at utilities over the weekend. ED was the closest. Bonds- even for short term - seems like too much interest rate risk - yield still too negative. SCHD - not a real value proposition at this point either. I think it's a stock pickers' market - and not just because I'm one.  On the eve of recession - mighty hard to think that with jobs where they are. I do think there is a lot of chatter about inverted curves and recession. A lot of smart people saying the Fed funds rate is going more north than the market thinks.  So - if that rate gets to 3 or 4 percent relatively soon - getting back to R48's comment - why buy utilities? Why not a 2 year at that point? 

[bizman]

All I know is that I think I must be getting a lot stupider as I age, because I feel outmatched by all the variables and potential outcomes. I know I'm not David Tepper or Peter Lynch, and my circle of competence doesn't include all sectors nor all stocks.

I do know I'm not a fan of fixed income, until and unless rates go much higher, and/or inflation looks like it's getting back into control. My problem with all the people calling for inflation to just subside naturally is that it seems more like wish fulfillment than anything with any history or likelihood behind it.

Which is why I'm playing something close to maximum defense with 60% stocks so I have participation if things go well, and 40% cash because I'm not finding great buys that I really understand and want to load up on. And which is also why the market gods may well leave me in the dust as my IQ points seem to melt away.

[retiredat48]

Apr 4, 2022 19:36:27 GMT bizman said:

All I know is that I think I must be getting a lot stupider as I age, because I feel outmatched by all the variables and potential outcomes. I know I'm not David Tepper or Peter Lynch, and my circle of competence doesn't include all sectors nor all stocks.

Exactly, bizman.  Most should feel like you do...too many variables and potential outcomes.  ALWAYS.

I deal with this by concluding that most of the stuff is just "noise" in the market.  The best educated economist cannot sort out all the variables and tell you what will happen.  And even if incorrect, the market may treat it differently than expected.  Take inflation...is it bad or good for the market?  Investing 101 says stocks is the place to be if high inflation.  Don't be talked out of owning stocks/the means of production.

So for me, I get my portfolio management down to a simple set of strategic guidance factors and rules, and stay with it.  I invest making NO PREDICTIONS...just the most likely outcomes.  Probabilities.  Making investing rocket science is a mistake, IMO.

And remember bizman, you have some UNFAIR ADVANTAGES...for example, you can depart immediately by the click of a mouse, a bad mutual fund/ETF...or a bad portfolio.  Whereas the portfolio manager is stuck with it.  So no reason for any investor to own and stay with a laggard.

R48

[anitya]

Why the knock on SCHD? M* portfolio page indicates that dividend + cash flow growth is about 10%. 10 Yr Treasury is currently at 2.5%. Is 10% return for SCHD not enough margin of safety relative to the 10 yr Treasury, even if the 10 yr treasury were to have an outlandish terminal rate of 5% in this cycle?

[Deleted]

Apr 5, 2022 6:57:28 GMT anitya said:

Why the knock on SCHD? M* portfolio page indicates that dividend + cash flow growth is about 10%. 10 Yr Treasury is currently at 2.5%. Is 10% return for SCHD not enough margin of safety relative to the 10 yr Treasury, even if the 10 yr treasury were to have an outlandish terminal rate of 5% in this cycle?

No knock on SCHD.  I own 8 of its 10 top holdings.  I am not buying any of them right now either - other than reinvesting dividends. I just thinkg its expensive at this time.  For me.