The utilities sector (XLU) has remained nearly flat year-to-date when compared to the massive gains seen in other sectors in 2024, such as technology. Citi Equity Analyst Ryan Levine believes that the utilities sector's poor performance has gone on for too long, pointing to AI as "the real emerging story" that will "create a demand growth for the industry at large."
"There's two groups of companies — companies on the regulated utility side and then on the unregulated side," Levine explains to Yahoo Finance. "On the regulated side, companies as you articulate in terms of close proximity to the data center buildout. So we identify Georgia as a state that's very attractive and are recommending Southern Company (SO) on that theme."
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SEANA SMITH: Utilities stocks have been an underperformer so far this year. The Dow Jones Utility average and also the iShares Global Utilities largely remaining flat-- you can see it on your screen there-- since the start of the year, missing out on the market's broader rally.
Despite that underperformance, though, some on Wall Street see a bit of a buying opportunity within the sector. For more on that, we want to bring in Ryan Levine from Citi to help explain all this. Ryan, it's great to have you here. So talk to us just about the underperformance that we've seen in the utility sector really since the start of the year when you compare it to the broader market rally. Has some of that poor performance, has it gone a bit too far?
RYAN LEVINE: Yeah. So year to date, there's been a weakness due to interest rates, but also due to concerns around capital market activity and wildfire risk impacting the viability and the equity component of these stories. We think it has gone too far for a select group of stocks because the wildfire risk is largely in the rearview mirror, Xcel Energy, in particular, we think the liability is below their insurance.
Interest rate movements have been more constructive, but the real emerging story is around artificial intelligence and how that's going to create a demand growth story for the industry at large in order-- o oh, go ahead.
JARED BLIKRE: Yeah. Can you tell us exactly what that looks like? What kinds of utility companies are going to be positioned to best take advantage of this upswing? And AI I would imagine it has to do with proximity to data centers. You're going to have to factor in local government taxes, all kinds of things. But what kinds of utility companies are going to be able to participate in the AI revolution?
RYAN LEVINE: Yeah. So there's two group of companies-- companies on the regulated utility side and then on the unregulated side. On the regulated side, companies exactly as you articulate in terms of close proximity to the data center buildout. So we identify Georgia as a state that's very attractive and are recommending Southern Company on that theme.
On the unregulated side, this is more Texas and a handful of other select markets. There's opportunities for the merchant developers to build new power plants. But they're faced-- but their own challenge is data centers are willing to sign shorter-term contracts than would be needed to completely underwrite these new around-the-clock power sources.
SEANA SMITH: Ryan, when you take into account the counter part of this argument, right, people are out there saying, why buy utilities when you can just invest in bonds when you see a 10-year yield right around 4 or whatever it's trading at today, the highest level that we've seen in just about five months? If you're getting that type of yield in the fixed income market, why buy utilities? What do you say to that?
RYAN LEVINE: Yeah. So this AI growth story is really a big deal in terms of incremental electricity demand growth that has historically been growing between 0% and 2% annually per year, and we could see high single digit growth in select markets, which creates a big opportunity for new investments in power generation, as well as the wires, the electric distribution and transmission lines that will enable this revolution. So that's a story that the industry hasn't faced in recent history and creates an interesting inflection point to invest in select group of securities.
JARED BLIKRE: Ryan, could I-- I'd like to direct everybody's attention to the Y-Fi Interactive, and I'll describe this in case anyone can't see it. This is our utilities heat map. This is components of the XLU ETF, so large cap utilities. And what I notice here, this is year to date performance and it's pretty bifurcated.
We have a low here of GNE, that's Genie Energy, I'll put a 1-year chart, and you can see big mountain top there. CIG, this is another company. I'm just wondering what accounts for some of the bifurcation of returns that we're seeing here this year so far.
RYAN LEVINE: Yeah so the names that are performing well that we cover are driven more due to a couple factors. One is this AI growth story that's creating select opportunities for both regulated and unregulated utilities. In that group, there's also some names that were exposed to litigation and other factors that have been removed in terms of NextEra that they got an all clear with a key outcome and that's led to the recent outperformance.
And then also on there for NextEra, in particular, which is a large mover there, they had a successful analyst event in Florida a few weeks ago that shined the light on improved and quality returns that they're expected to get on their unregulated development business.