Utilities stocks, known for their stable business models and high-paying dividends, have found plenty of buying interest this year as investors flocked into the safe-haven sector to seek protection against market volatility caused by the prolonged U.S.-China trade dispute and constant chatter about a 2020 recession. Furthermore, a series of three interest rate cuts this year by the Federal Reserve has made the non-cyclical group an attractive alternative to yield-tumbling bonds.
In more recent times, market commentators have cautioned about the sector becoming too expensive amid lofty valuations among some of the nation's largest utilities companies. Bloomberg reported in September that utilities' valuation premium over the S&P 500 reached its highest level since 2007. Through Wednesday's close, the group trades at about 20 times forward earnings, while the average large-cap company carries a projected earnings multiple of roughly 18 times.
From a technical perspective, the three utilities companies outlined below have formed topping patterns over the past month, indicating that the bulls may be zapped of energy. Let's take a more in-depth look at each power provider and identify some trades to consider.
American Electric Power Company, Inc. (AEP)
American Electric Power Company, Inc. (AEP) provides electricity generation, transmission, and distribution to more than 5 million retail customers in 11 states. The Columbus, Ohio-based utility generates its electricity using coal, natural gas, nuclear, hydroelectric, solar, and wind. While the company exceeded bottom-line expectations in the third quarter (Q3), revenues of $4.30 billion fell short of Street expectations and decreased 0.60% on a year-over-year (YOY) basis. From a valuation standpoint, the stock trades nearly 21 times forward earnings – well above its five-year average of about 18 times. American Electric Power stock has a market capitalization of $46.21 billion, offers a dividend yield of almost 3%, and is trading up 24.98% on the year as of Nov. 7, 2019.
The utilities giant saw its share price trend consistently higher between January and September, with retracements barely reaching the 50-day simple moving average (SMA). As the stock reached a fresh 52-week high/all-time high in late October, a bearish divergence formed between price and the relative strength index (RSI) – indicating waning buyer enthusiasm and warning traders of a possible double top. Those who open a short position at current levels should anticipate a move down to $86, where price may catch a bid as it nears support from a horizontal trendline and the 200-day SMA. Implement risk management by placing a stop-loss order just above this month's high at $94.98.
The Southern Company (SO)
The Southern Company (SO) engages in the generation, transmission, and distribution of electricity through four divisions: Gas Distribution Operations, Gas Pipeline Investments, Wholesale Gas Services, and Gas Marketing Services. The $65.83 billion utilities firm generates 50 gigawatts of capacity, primarily for serving customers in Georgia, Alabama, and Mississippi. Atlanta-based Southern Company posted Q3 earnings per share (EPS) of $1.34 compared to $1.14 in the year-ago quarter. However, revenue for the period slipped 2.7% YOY, affected by asset dispositions and weaker residential and industrial electricity sales. Southern Company stock trades at 19.46 times its estimated earnings for the next 12 months, representing an 18% premium to its five-year historical average. Trading at $61.85 and paying an annual $2.48 dividend, the stock has returned 45% year to date (YTD), powering 22% ahead of the S&P 500 over the same period as of Nov. 7, 2019.
On a first glance at the company's chart, the adage "the trend is your friend" comes to mind. However, looking more closely at price action over the past two months tells a different story. As the stock printed an all-time high just above $63 to start November, the RSI formed a shallower relative peak, again suggesting buyer fatigue and flashing a bearish divergence. Traders who want to position for a possible bull trap may decide to wait for a close below $60 to confirm the topping pattern. Once in a trade, think about buying to cover near $54.50 – an area that finds a confluence of support from previous price action and the 200-day SMA. Keep downside minimized with a stop order above the all-time high.
Eversource Energy (ES)
Springfield, Massachusetts-based Eversource Energy (ES) provides regulated electric, gas, and water distribution services to roughly 4 million customers in the Northeastern United States. The 92-year-old utilities company posted Q3 adjusted earnings of 98 cents per share on revenues of $2.18 billion. The firm's bottom line delivered an earnings surprise of 4.26%, while its top line missed analysts' expectations and fell 4% from the quarter ending September 2018. Swiss investment bank UBS Group downgraded Eversource Energy stock to "neutral" from "buy" in late October due to its premium valuation and strong absolute and relative YTD price performance. As of Nov. 7, 2019, the firm's shares have a forward price-to-earnings ratio (forward P/E) of 22.27 compared to a five-year average multiple of 18.53. Eversource Energy stock issues a 2.56% dividend yield and has gained 27.61% YTD.
Eversource Energy's share price tracked the 50-day SMA higher for most of this year but has broken down below the closely watched indicator this month to herald a change in market structure. Instead of chasing the breakdown, look to short the stock at the $84 level, where price finds resistance from the topping pattern's neckline along with headwinds from the 50-day SMA. Those who do execute a short sale should set a take-profit order down near crucial support at $75 and protect trading capital, with a stop positioned slightly above the Oct. 25 all-time high at $86.55.