FUTY - XLU: This SWAN Should Soar In '24

2024-01-13 07:00:00 ET

Summary

• The utility sector was one of the worst-performing sectors in 2023, with a return of -10% compared to the S&P 500's +24% return.
• However, the sector closed the year strong, climbing 13% in the last three months.
• The prospects for the utility sector in 2024 are looking more positive, as the Federal Reserve indicated potential rate cuts, which could attract income investors back to utility stocks.

If there was one sector you didn't want to have exposure to in 2023, it was the utility sector.

Utilities were one of the worst performing sectors in 2023 by a wide margin. Here are the returns as compared to the S&P 500:

• S&P 500 2023 Return: +24%
• Utilities Select Sector SPDR ETF ( XLU ): -10%

However, the utility sector did close the year strong, climbing 13% over the last three months, slightly outperforming the greater S&P 500.

2023 was a rough year, but does that end-of-year rally mean that the sector could have some life in 2024?

In today's piece we'll look into what went wrong in 2023 as well as the prospects for 2024 and take a closer look at the popular utility ETF, Utilities Select Sector SPDR Fund ETF ((XLU)).

What Went Wrong For Utilities in 2023

When discussing utility companies, they're not usually for investors looking for huge amounts of growth. Utility companies are more of a necessity for consumers, and there's very little in terms of innovation that can take place.

When you think of a company like Apple ( AAPL ) or Meta Platforms ( META ), they have pricing power with current product offerings, but they also can innovate and bring completely new products online to generate top line revenue growth.

This isn't really the case when it comes to utility companies. These stocks provide energy and natural gas, often regulated by governments with how much they can increase prices.

As such, utility stocks are more for investors looking for income, as the sector can tend to offer low value stocks at times that come with higher income through dividends.

Given that, when the sector is more connected with income, that made 2023 and even 2022 a struggle given that we have seen 11 rate hikes from the Federal Reserve since March 2022.

This has increased the rate across a number of products, including the likes of high yield savings accounts, where you can now get a HYSA with a 4.5%-plus yield that comes with little to no risk.

Investors are looking at their portfolio, seeing that they can get their income with little to no risk, and a lot of investors moved their investments out of these types of stocks in 2023.

Why 2024 Could Be Different For Utilities

However, now that rate hikes appear to be in the rearview mirror, and the Fed has indicated that rate cuts are in the near future, this is bullish for utilities.

In Q4 the Federal Reserve indicated potential rate cuts in 2024, which coincides with the move in the utility sector we have seen.

As rates start to come down, financial institutions will lower the interest rates on high-yield savings accounts and US Treasury rates will fall as well.

Lower rates on more risk-free products will bring income investors or those investors looking for some quality yield back to utility stocks.

As is the case with all sectors, you can invest in individual stocks and increase the risk in your portfolio, or you can take a more diversified approach and add a high-quality, low-cost ETF to your portfolio.

So today I will highlight the utility ETF.

XLU: A Low Cost Way To Gain Exposure To Utilities

The XLU is an exchange traded fund that was formed in 1998 and launched by State Street Global Advisors.

To no surprise, the ETF focuses strictly on stocks within the utility sector, which includes companies from the following industries: Electric utilities, water utilities, multi-utilities, independent power and renewable electricity producers, and gas utilities.

XLU has a low expense fee of 0.10%, meaning each investor will pay $10 for every $10,000 invested.

Here's a look at XLU's performance over the last 10 years. As you can see, up until the pandemic hit, XLU was actually tracking or outperforming the S&P 500.

Here's a look at the top 10 stocks within the XLU:

As I mentioned earlier, the utility sector usually coincides with higher income, via dividends.

XLU currently yields a dividend of 3.3% and the dividend has been growing for 13 consecutive years and counting.

Quick Look At The Top 3 Positions

Let's now take a closer look at XLU's top positions:

Position #1 - NextEra Energy ( NEE )

NextEra Energy operates in two segments, with one being the largest utility company in the US. This is a high-quality energy company and a way to play the transition to more renewable resources. NEE has a market cap of $129 billion.

Analysts are expecting EPS of $3.40 per share in 2024, which equates to a forward P/E ratio of 18.5x, which is below the company's 10-year average of 24x.

Position #2 - The Southern Co ( SO )

The Southern Company is a utility company that generates and distributes electricity. It operates through three segments:

• Gas Distribution Operations
• Gas Pipeline Investments
• Gas Marketing Services

SO has a market cap of $78.7 billion.

Analysts are expecting EPS of $4.02 per share in 2024, which equates to a forward P/E ratio of 17.9x, which is in-line with the company's 10-year average of 18x.

Position #3 - Duke Energy ( DUK )

Duke Energy operates as an energy company in the United States. It operates through two segments:

• Electric Utilities and Infrastructure (EU&I)
• Gas Utilities and Infrastructure (GU&I)

The EU&I segment generates, transmits, distributes, and sells electricity. This segment also uses renewable resources to generate electricity. The GU&I segment distributes natural gas.

DUK has a market cap of $76.6 billion.

Analysts are expecting EPS of $5.97 per share in 2024, which equates to a forward P/E ratio of 16.6x, which is below the company's 10-year average of 18x.

In Closing

Seeking Alpha's Rating Tracker:

Seeking Alpha's ETF Grades:

XLU's expense ratio is just 10 basis points (hence the A grade) and the dividend score is A+ (as seen below):

The current dividend yield is 3.33% and the total assets under management is $14.6 billion. As Seeking Alpha writer Steven Fiorillo points out,

"Utilities look to be attractive as XLU's top-10 holdings have significant double-digit EPS growth over the next two years, and trade for under 20x earnings based on their projected 2023 EPS while getting cheaper on a forward basis with an average 2025 forward P/E of 15.14x."

XLU is set to surge in 2024 as the Federal Reserve is ending its tightening cycle with anticipated rate cuts in 2024 and 2025. I'm adding this boring utility ETF to my portfolio as this SWAN (sleep well at night) should soar in 2024.

Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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