The recent spike in interest rates has led to a crisis-like selloff in the utilities sector, creating historically attractive buying opportunities for investors. Sophie Karp from KeyBanc Capital acknowledges this and has raised her rating on a handful of companies while reiterating her bullish call on others.
In a research report titled "Utilities: Close Your Eyes and Buy (Quality)," Karp explains that the recent market selloff has resulted in valuation dislocations that investors can benefit from. She believes that the volatility in the utilities space presents an opportunity for investors to take advantage of the situation.
The Utilities Select Sector SPDR ETF (XLU) has experienced a significant decline, slumping 1.3% in midday trading Thursday. This puts it on track for its lowest close since June 26, 2020. The ETF has dropped over 16% since the end of July, with declines comparable to those seen during the height of the COVID crisis in March-April 2020 and the financial crisis of late 2008 into early 2009.
At the same time, the yield on the 10-year Treasury note (BX:TMUBMUSD10Y) has risen by 0.76 percentage points, reaching 4.80% on Oct. 3. This is the highest yield seen since August 2007.
The current state of utilities stocks is further highlighted by a Bespoke chart, which shows that rising rates have "decimated" these stocks and pushed them into uncommon trading territory.
Despite the challenging environment, Karp's research identifies attractive buying opportunities in the utilities sector. Investors should consider leveraging these opportunities to their advantage.
Read: How rapidly rising Treasury yields are shaking up financial markets — in 5 charts.
Also read: Utilities stocks 'decimated' by rising rates fall into uncommon trading territory, Bespoke chart shows.
Utilities ETF's Dividend Yield and Valuations Signal Opportunity
The recent selloff of the utilities ETF has resulted in a significant increase in its dividend yield, making it the highest yield among the SPDR ETFs that track the S&P 500's 11 sectors. Currently standing at 3.78%, this yield is more than double the implied yield for the S&P 500 index, which is 1.64%.
Due to the market volatility, valuations within the utilities sector have reached levels not seen in over a decade, excluding a brief period during the early stages of the pandemic. Recognizing this unique situation, experts suggest that investors focus on higher quality utility stocks, which are now available at historically low valuations compared to the utilities index.
In the "high quality" category, CenterPoint Energy Inc., CMS Energy Corp., and DTE Energy Co. have been upgraded from sector weight to overweight. Additionally, Ameren Corp., WEC Energy Group Inc., and Xcel Energy Inc. have retained their overweight ratings.
Out of these stocks, DTE Energy's valuation stands out as it trades at the lowest premium to the overall sector's average valuation multiple. Furthermore, DTE Energy also boasts the highest dividend yield among this group at 3.95%.
Moving towards the "value spectrum," Entergy Corp.'s stock has been upgraded to overweight from sector weight, indicating potential value for investors. FirstEnergy Corp. and NorthWestern Energy Group Inc. continue to maintain their overweight ratings as well.
Among these stocks, Entergy's stock is trading at the deepest discount to the group's average valuation. On the other hand, FirstEnergy offers the highest dividend yield within this group, currently at an impressive 4.89%.
In summary, the utilities sector's recent selloff has created an opportunity for investors. With increased dividend yields and improved valuations, focusing on high-quality utility stocks is recommended. Furthermore, stocks within the value spectrum, such as Entergy Corp., also offer potential value. By carefully analyzing these factors, investors can make informed decisions to capitalize on the current market conditions.
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