There has been an unending stream of debate about the possibility of a rate hike by the Fed at the September meeting that is currently underway. The much-awaited decision will be delivered at 2 p.m. today, followed by a conference by Fed Chairwoman, Janet Yellen.
The past few weeks have seen a number of Fed officials providing mixed comments regarding a rate hike in September. If the FOMC does not hike the interest rate this month, the next probability for the same lies in December. No changes are expected in the November meeting due to the proximity to the general elections as well as the lack of a scheduled press conference by the Chair post the meeting.
The Fed Stance
The probability of a rate hike at the September meeting increased significantly after Yellen’s speech at Jackson Hole where she stated that the case for a rate hike had “strengthened in recent months”. Post the speech, another voting Fed member, Fischer, acknowledged that Yellen’s comments could mean a rate hike in September and perhaps two hikes in the year.
Earlier in the month, several Fed officials commented on the need for a rate hike. While some expect and advocate it sooner this month, some believe the Fed can afford to be patient for a hike later this year. A number of financial analysts and economists are expecting the hike this month itself. Although a near-term hike is uncertain, the probability of a rate hike before the year is out remains high.
Utility: A Sector to Avoid
Utility stocks are a favorite with conservative investors. The companies in this space provide low-risk stocks with a high yield, making them particularly appealing in a bearish market. However, utilities are an expensive business to ensure maintenance of nonstop supply of basic amenities including fresh water, gas and electricity, which require a large inflow of funds. The capital-intensive companies are subject to significant adverse impact caused by interest rate hikes.
Utility companies typically have high levels of debt as they require constant infusion of funds for organic growth as well as for infrastructure upgrade projects. The funds generated from the operations of the company are utilized more for dividend payouts, with a relatively lower percentage being invested back as capital.
An increase in interest rates would raise the borrowing costs considerably, weighing on profits which in turn will affect the dividend-paying capacity of these companies. Moreover, companies in the sector are preferred over bonds due to their high dividend yields. But a higher interest rate would make bonds more appealing to investors. An increase in the interest rate would likely adversely impact utility companies by making it costlier for them to borrow funds.
Stocks to Avoid
We have screened five utility stocks that should be avoided if the Fed hikes rates. These stocks already pay out a relatively low dividend yield compared to the rest of the companies in the sector. If the Fed raises rates, the dividend yield might fall further, thus reducing the appeal of these companies.
Moreover, these stocks have been trading near their 52-week high prices. If the companies in the sector face a contraction, these stocks are likely to plunge lower than their counterparts. The fact that these stocks hold a sell-rated Zacks Rank further supports our expectation.
Black Hills Corporation BKH is an energy company that generates wholesale electricity and produces natural gas, crude oil and coal. The company’s last closing price of $60.22 is 83.5% of its 52-week high of $64.58. The company has a dividend yield of 2.79% and currently holds a Zacks Rank #4 (Sell).
El Paso Electric Co. EE, a public utility company is engaged in the generation, transmission and distribution of electricity in an area of west Texas and southern New Mexico. It also serves wholesale customers in Texas, New Mexico, California and Mexico. The company’s last traded price of $46.92 is 87.3% of its 52-week high of $48.38. It has a dividend yield of 2.66% and currently holds a Zacks Rank #4.
The Hong Kong and China Gas Company Limited HOKCY was the first public utility in Hong Kong. The company’s core business comprises production and distribution of gas, marketing of gas and appliances, and comprehensive after-sales services. The company’s last traded price of $1.87 is 90% of its 52-week high of $1.88. It has a dividend yield of 1.99% and currently holds a Zacks Rank #4. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
PG&E Corporation PCG is the parent holding company of California’s largest regulated electric and gas utility, Pacific Gas and Electric Company. It engages in electricity and natural gas distribution, generation, transportation and storage. The company’s last traded price of $62.55 is 82.2% of its 52-week high of $65.43. This Zacks Rank #4 company has a dividend yield of 3.13%.
WEC Energy Group, Inc. WEC is a diversified holding company, engaged in the generation and distribution of electricity in southeastern, east central and northern Wisconsin, as well as in the upper peninsula of Michigan. The company’s last traded price of $61.26 is 75.4% of its 52-week high of $66.10. It has a dividend yield of 3.22% and currently holds a Zacks Rank #4.
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