October 2024, From the Field -
The utilities sector is in the midst of a seismic change as energy shifts away from coal and natural gas and toward renewable energy sources like wind, solar, and hydrogen. Forward‑looking utility companies are investing significantly in the infrastructure for the new forms of energy generation, storage, and transmission that will be vital now and into the future.
We think one of the reasons the sector has been miscast as merely a defensive, low‑growth sector is the persistent notion that investing in utilities is a play on interest rates because they are often seen as an alternative to bonds due to their historically competitive dividend yield.1 Today’s utilities aren’t your grandfather’s utilities, though. In fact, we think the sector may provide better long‑term, risk‑adjusted returns than many other U.S. equity sectors, even those that are perceived to be more growth oriented.
Many companies in higher‑growth sectors such as information technology pay low or no dividends, instead reinvesting capital in ways intended to spur future growth and capital appreciation, such as research and development focused on new products or services. Conversely, companies with stable revenue streams and demand may not pursue long‑term growth and capital appreciation. Instead, they tend to distribute profits in the form of dividends, which can be attractive for many investors, particularly those focused on current income.
"...the urgent transition to renewable energy will be a significant driver of utilities companies reinvesting capital in a way that should change how we value them."
Utilities companies have long been placed in this latter basket. However, the urgent transition to renewable energy will be a significant driver of utilities companies reinvesting capital in a way that should change how we value them. Moreover, while the transition to renewables is still underway, many of the impacts of climate change are already here. Utilities companies are in a position where they need to spend significant capital to harden their grids to protect from natural disasters like storms and wildfires and the impact from ever‑increasing extreme weather events like the winter storms that crippled Texas’ power grid in 2021.
These forces are driving a powerful capital expenditures cycle that can be a catalyst for earnings growth as companies that are investing ahead of change begin to realize the benefits of new infrastructure and capabilities. We think the commonly accepted narrative on utilities underappreciates the transition in the sector, where a number of companies have been:
Just as utilities have been mispriced as bond proxies because of long‑standing assumptions, the sector has also historically been pressured by uncertainty around rate cases. In short, utility rate cases are a form of government regulation that determines the rates that a regulated utility can charge for electricity, natural gas, water, and other services. These cases have a significant impact on growth and return on equity.
"...we think adverse outcomes are the exception to a pattern of generally constructive outcomes between utilities and regulatory commissions across the country."
On occasion, such as in a 2023 rate case ruling in Illinois, adverse outcomes do result in less favorable operating environments. This surprising ruling took place in a time when almost every other commission has pushed utilities to make investments to harden the grid, to make investments to enable more renewable resources, and to replace aging infrastructure to reduce storm damage and increase reliability. In that light, we think adverse outcomes are the exception to a pattern of generally constructive outcomes between utilities and regulatory commissions across the country. Setting aside the outcome in Illinois, the vast majority of rate cases across dozens of states have resolved positively with solid rate base2 growth and, overall, slightly improved returns on equity.
We think concerns over unlikely and adverse rate case rulings, which are typically driven by idiosyncratic factors, contribute to an entire sector being structurally undervalued when we account for potential dividend yields and long‑term growth.
As investors, we’re willing to go against consensus, question commonly held assumptions, and follow through on our research and process. The utilities sector offers one such opportunity to cut against the grain and pursue attractive risk-adjusted returns in an area we think the market underappreciates and misunderstands. Whether through fundamental research, taking a longer view, or asking the right questions, we are committed to uncovering opportunities that can add value for our shareholders.
David R. Giroux
Portfolio Manager, Capital Appreciation Fund and Capital Appreciation Equity ETF; Co‑portfolio Manager, Capital Appreciation and Income Fund
David Giroux is a portfolio manager for the Capital Appreciation Strategy, including the Capital Appreciation Fund and Capital Appreciation Equity ETF, and co-portfolio manager for the Capital Appreciation and Income Fund at T. Rowe Price Investment Management. He also is head of Investment Strategy and chief investment officer for T. Rowe Price Investment Management. David is the chairman of the Capital Appreciation and Capital Appreciation Equity ETF Investment Advisory Committees and a cochairman of the Capital Appreciation and Income Investment Advisory Committee. He is a member of the T. Rowe Price Investment Management ESG Investing Committee and the T. Rowe Price Investment Management Investment Steering Committee. David is a six-time nominee and two-time winner of Morningstar's Fund Manager of the Year award.1 His fund also has won 22 Best Fund awards2 from Lipper. David is a vice president of T. Rowe Price Group, Inc.
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1 Established in 1988, the Morningstar Fund Manager of the Year award recognizes portfolio managers who demonstrate excellent investment skill and the courage to differ from the consensus to benefit investors. The Fund Manager of the Year award winners are chosen based on research and in-depth qualitative evaluation by Morningstar's Manager Research Group. To qualify for the award, managers' funds must have not only posted impressive returns for the year, but the managers also must have a record of delivering outstanding long-term risk-adjusted performance and of aligning their interests with shareholders'. Managers' funds must currently have a Morningstar Analyst Rating™ of Gold or Silver. David Giroux won the award for Allocation Funds in 2012 and Allocation/Alternative Funds in 2017.
Morningstar's Manager Research Group consists of various wholly owned subsidiaries of Morningstar, Inc., including, but not limited to, Morningstar Research Services LLC. Morningstar's Manager Research Group produces various ratings including the Morningstar Analyst Rating for funds and the Morningstar Quantitative Rating for funds. The Analyst Rating is derived from a qualitative assessment process performed by a manager research analyst, whereas the Morningstar Quantitative Rating uses a machine-learning model based on the decision-making processes of Morningstar's analysts, their past ratings decisions, and the data used to support those decisions. In both cases, the ratings are forward-looking assessments and include assumptions of future events, which may or may not occur or may differ significantly from what was assumed. The Analyst Ratings and Quantitative Ratings are statements of opinions, subject to change, are not to be considered as guarantees, and should not be used as the sole basis for investment decisions. This press release is for informational purposes only; references to securities should not be considered an offer or solicitation to buy or sell the securities.
©2024 Morningstar, Inc. All Rights Reserved.
2 The Capital Appreciation Fund received the 2024 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 5-year and 10-year periods ended 12/31/2023, the 2023 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 3-year, 5-year, and 10-year periods ended 12/31/2022, the 2022 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2021, the 2021 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2020, the 2020 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2019, the 2019 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2018, the 2018 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2017, the 2017 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2016, the 2016 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 3-year, 5-year, and 10-year periods ended 12/31/2015, the 2015 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/14, the 2014 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2013, the 2013 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2012, the 2012 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2011, the 2011 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2010, the 2010 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 5-year and 10-year periods ended 12/31/2009, and the 2009 Lipper Fund Classification Award for Best Mixed-Asset Target Allocation Growth Fund over the 10-year period ended 12/31/2008.
Rankings for other periods differ. For Lipper Best Individual Funds, the calculation periods extend over 36, 60, and 120 months. The highest Lipper Leader for Consistent Return (Effective Return) value within each eligible classification determines the fund classification winner over 3, 5, or 10 years as of the period-end and no other time periods. Only one share class (the one with the best Lipper Leader score) is used for each portfolio in determining asset class and overall awards. A high Lipper rating does not necessarily imply that a fund had the best total performance or that the fund achieved positive results for that period. Lipper ratings and Lipper Fund Awards are not intended to predict future results. For a detailed explanation, please review the Lipper Leaders Methodology document on lipperfundawards.com/Methodology.
From Thomson Reuters Lipper Awards, © 2018 Thomson Reuters. All rights reserved. Used by permission and protected by the Copyright Laws of the United States. The printing, copying, redistribution, or retransmission of this Content without express written permission is prohibited.
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1Dividends are not guaranteed and are subject to change.
2Rate base is the net value of a utility’s plant, property, and equipment on which it can earn a return.
Utilities risks: The utilities industries can be significantly affected by government regulation, financing difficulties, supply and demand of services or fuel, and natural resource conservation. They are subject to interest rate risk (higher interest rates have typically pressured utilities because they reduce the present value of future dividends and bond yields also typically become more competitive with the dividend yields offered by the stocks).
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This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of October 2024 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
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