The utilities sector encompasses all companies whose core business involves producing, generating or distributing the basic utilities: gas, electricity and water. The average debt-to-equity ratio, or D/E ratio, for the utilities sector in 2018 was 0.68. In the fourth quarter of the year, it reached a sector high of 2.38, which was enough for Moody's Investors Service to issue and maintain a negative outlook on U.S. regulated utilities for 2019.
The D/E ratio is a metric used to determine the degree of a company's financial leverage. Since utilities typically carry high-debt levels, they are subject to interest rate risk, and the D/E ratio is an important metric for evaluating the overall financial health of a company. The stocks of utilities sector companies generally tend to perform best when interest rates fall or are low.
Calculating the D/E Ratio
To calculate a company's D/E ratio, you divide its total liabilities by the amount of equity provided by stockholders. This metric reveals the respective amounts of debt and equity a company uses to finance its operations. The D/E ratio for a sector can be determined by calculating and averaging the D/E ratios for all of the companies within the sector.
When a company’s D/E ratio is high, it usually suggests the company has taken an aggressive growth financing approach with its debt. One issue with this approach is additional interest expenses can often cause volatility in earnings reports. If earnings generated are greater than the cost of interest, shareholders benefit. However, if the cost of debt financing outweighs the return generated by the additional capital, the financial load could be too heavy for the company to bear.
D/E Considerations for the Utilities Sector
Evaluating a company using the D/E ratio is dependent on the company's industry. Capital-intensive industries such as utilities have relatively higher D/E ratios. Therefore, D/E ratios should be considered in comparison to similar companies within the same industry. Generally, ratios of 0.5 and below are considered excellent, while ratios above 2.0 are viewed more unfavorably.
Utilities often carry high debt levels as their infrastructure requirements make large, periodic capital expenditures necessary. However, they also have a large amount of investment equity because they are such "bedrock" stocks; they are included in the investment portfolio of many funds and individual investors.