What is the 'Utilities Sector'

The utilities sector is a category of stocks for utilities such as gas and power. The sector contains companies such as electric, gas and water firms, and integrated providers. Because utilities require significant infrastructure, these firms often carry large amounts of debt; with a high debt load, utilities companies become sensitive to changes in the interest rate.

BREAKING DOWN 'Utilities Sector'

As high-yielding equity investments, utility stocks are subject to interest rate risk. As a result, higher interest rates mean increased cost of capital for utility companies. For example, in 2015, the U.S. Environmental Protection Agency (EPA) proposed a plan for lowering carbon pollution from domestic power plants by 30% from 2005 levels by 2030. Electric utilities relying mostly on coal and without appropriate retrofit for scaling down their carbon footprint would be the most affected. DTE Energy management estimated needing $15 billion to upgrade energy infrastructure to match the EPA’s required environmental standards. The company would need to invest approximately $7 billion to $8 billion to meet the energy policy’s standards.

Debt Levels of the Utilities Sector

Because utilities are capital-intensive, they need a continuous inflow of funds for carrying on their infrastructure upgrades and growth. The processes are necessary for maintaining the continuous supply of electricity, fresh water, gas and other basic amenities. Utilities use some funds generated from operations, but most funds are used for paying dividends. External sources are typically used for financing capital requirements.

As a result of relying on other financing methods and depending on market conditions, utilities companies may end up paying higher interest rates on their debt. Borrowing at higher rates contributes to the companies’ increasing debt levels, resulting in steep debt-to-equity ratios impacting the companies’ credit ratings. When credit ratings go down, utilities companies have difficulty borrowing funds at reasonable rates. As a result, the cost of operations increases.

Consumer Impact on Utilities Sector

Because many states let consumers move from one utility operator to another, consumers typically choose the least expensive operator in the area. Higher-cost producers are eventually eliminated from the market unless they can cut their costs.

Long-term power purchase agreements between companies and consumers also impact profits. When utility generation costs increase, companies still have to follow contract agreements and sell utilities at preset rates, which decreases their profits.

Because utility stocks pay reliable dividends like bonds do, the stocks compete with bonds as consumer investment options. After the financial crisis of 2008, and the resulting almost-nonexistent interest rates lasting a long time, utility companies benefited from conservative investors buying the companies’ stocks rather than bonds. In contrast, increasing interest rates make buying bonds more attractive than buying utility sector stocks, further affecting utilities companies’ funding. The Utilities Select Sector SPDR Fund (XLU) pays a dividend yield of 3.5% as of January 2018, well above the yield of the S&P 500 and the U.S. 10-year Treasury note.

Growth in the housing sector may trigger growth in the utilities sector as demand for electric power and water increases. 

Upside of Utilities Investments

In addition to packing hefty dividends, stocks in the utilities sector tend to be reliable and slow but steady growers if held for the long term. Thus, investment managers often include them in a defensive or income-oriented portion of a portfolio. Conservative investors also turn to them in economic downturns when other stocks can become more volatile. 

Downsides of Utilities Investments 

Investors in the utilities sector should be mindful of a variety of risks, despite government regulations that offer some stabilization. Economic growth, changing environmental regulation and increasing interest rates can all negatively impact companies and erode or lead to cancelation of dividend yields. In addition, natural disasters and changing commodity prices may hit their bottom lines. 

RELATED TERMS
  1. Utility

    Utility is an economic term referring to the total satisfaction ...
  2. Sector Fund

    A sector fund is a fund that invests solely in businesses that ...
  3. Energy Sector

    The energy sector is a category of stocks that relate to producing ...
  4. SEC Form 35-CERT

    A now-obsolete filing with the Securities and Exchange Commission ...
  5. Telephone Bond

    Telephone bonds are debt obligations issued by telephone or telecommunication ...
  6. Bernoulli's Hypothesis

    Bernoulli's hypothesis states a person accepts risk not only ...
Related Articles
  1. Insights

    Trust In Utilities

    Even in times of economic turmoil, utilities can be a good investment.
  2. Investing

    The Debt Report: The Utilities Sector

    Discover how blue chip U.S. utilities companies are using debt, and why it was important for the industry to deleverage after the financial crisis.
  3. Investing

    How Utilities ETFs Deal With Rising Rates

    Utilities stocks and ETFs may be vulnerable to rising interest rates, but there are other factors to consider.
  4. Investing

    A Surprising Sector Is Leading in August

    While other sectors sag, utilities are heating up in August.
  5. Investing

    The Top 5 Utility Mutual Funds for 2016

    Understand how utilities equities play a role in asset allocation, and discover the best utilities mutual funds to consider for 2016.
  6. Trading

    Invest in Utilities With These ETFs (XLU, JXI)

    The strong uptrends shown on the charts of these utility ETFs suggest now could be the time to buy.
  7. Investing

    The 4 Largest Utilities ETFs (XLU, VPU)

    Learn about the utilities sector, and discover the top four exchange-traded funds that can be used to gain investment exposure including XLU and VPU.
  8. Investing

    VPU Vs. XLU: Comparing Utilities ETFs

    Discover why utilities is the only U.S. stock sector that has managed to gain in early 2016, and review a comparative analysis of the Vanguard and SPDR Utilities ETFs.
  9. Trading

    3 Charts Suggest Traders Are Flocking to Safety of Utilities

    The rise in utility stocks over the past several weeks suggests that traders are turning to the safety of reliable sectors such as utilities for growth.
  10. Investing

    4 Utility Stocks that May Stay Bright

    With interest rates likely rising in the next year or so, there are a few utility stocks with potential to outperform their peers.
RELATED FAQS
  1. To what extent are utility stocks affected by changes in interest rates?

    Explore the current state of the utilities sector, and learn about the different ways an increase in interest rates may impact ... Read Answer >>
  2. What is the downside of investing in the utility sector?

    Learn about the pros and cons of investing in the utility sector, and determine whether the steady dividend income possibility ... Read Answer >>
  3. Why do utility stocks pay high dividends?

    Learn why utility stocks pay high dividends and how government-produced monopoly protects privileged utility companies from ... Read Answer >>
  4. What is the concept of utility in microeconomics?

    Read about the concept of utility in microeconomics, and learn why economists disagree about its usefulness in the analysis ... Read Answer >>
  5. What price-to-earnings ratio is average in the utilities sector?

    Explore the utilities sector, and discover how it compares to other market sectors when evaluated using the popular price-to-earnings ... Read Answer >>
  6. What is the utility function and how is it calculated?

    Economists measure utility in revealed preferences by observing consumer choices and ordering consumption baskets from least ... Read Answer >>
Trading Center