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. Electric Utilities Industry ETF

    A utilities industry ETF is an exchange-traded fund that invests ...
  2. Utility Revenue Bond

    A utility revenue bond is a debt security which is designed to ...
  3. Rig Utilization Rate

    The rig utilization rate describes the number of oil drilling ...
  4. Lease Utilization

    Lease utilization is a financial ratio that measures how much ...
  5. Sector Fund

    A sector fund is a fund that invests solely in businesses that ...
  6. SEC Form U-3A3-1

    SEC Form U-3A3-1 is an obsolete form previously required to be ...
Related Articles
  1. Investing

    Utility Funds: A Bright Choice In Bear And Bull Markets

    Gas, electric and water companies' non-cyclical nature can power strong gains in any portfolio.
  2. Insights

    Trust In Utilities

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

    ETF Flows: Utilities ETFs Stand Tall in 2016

    Find out which utilities exchange-traded funds (ETFs) have benefited the most from the huge surge in fund inflows in the early part of 2016.
  5. Investing

    A Surprising Sector Is Leading in August

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

    XLU: Utilities Select Sector SPDR ETF

    Learn about the Utilities Select Sector SPDR ETF and the benchmark index it tracks, and understand what type of investors may be interested in the fund.
  7. 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.
  8. Investing

    Utilities Sector: Industries Snapshot (NEE, GAS)

    Discover how the utilities sector is broken down into different subcategories that each function to fill a different need.
  9. Investing

    Utilities ETFs to Date 2016 Performance Review (UPW, FXU)

    Discover the best and worst performing exchange-traded funds (ETFs) within the domestic and international utilities sector year-to-date.
  10. Investing

    Why Utilities are the Hottest Sector (XLU)

    The performance of utilities has made it the hottest sector this year.
RELATED FAQS
  1. What kind of investors buy utility stocks?

    Take a look at why income investors like utilities, why value investors might like utilities and why growth investors tend ... Read Answer >>
  2. Why do utility stocks pay high dividends?

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

    Read about the concept of utility in microeconomics, and why economists disagree about the usefulness of cardinal utility ... Read Answer >>
  4. What debt/equity ratio is typical for companies in the utilities sector?

    Discover how the debt/equity ratio is used to measure a company’s leverage, and learn the typical debt/equity ratios for ... Read Answer >>
  5. 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 >>
  6. How strongly does government regulation impact the utilities sector?

    Read about the impact of government regulation on the utilities sector, particularly as is pertains to the water and electricity ... Read Answer >>
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center