Utilities (NYSEARCA: FOOTY) has been the worst-performing sector among Stoxx 600 (STOXX) stocks so far this year, with a -5.8% retracement, according to analysts at JPMorgan.
The second sector with the worst performance since the beginning of the year is real estate, also around -5.8%.
In a global In the market strategy report, analyst Mislav Matejka wrote that the sector has seen a highly leveraged bond proxy and is the preferred short “as investors position themselves for higher bond yields.”
Therefore, even if bond yields rise, the overall market could collapse, making the low beta of the utilities sector (FUTY) more attractive.
Furthermore, due to low levels of the VIX Index (VIX) – down 11.23% over the past six months – and growing geopolitical uncertainty with oil prices up nearly 25% from the recent low, “ the overall stock market may be too complacent as it stands,” Matejka said.
In the report, analysts list several scenarios in which the sector could outperform the market regardless of the direction of returns.
- Strong cash generation reduces concerns about the sector’s leverage. Net debt to EBITDA for utilities (FUTY) is 3.1x, among the most indebted European sectors. “The sector is generally well capitalized and is well positioned to access more funds to finance capital requirements,” the report said.
- Electricity prices have fallen significantly in recent months, but further decline may be limited as they are falling.
- Industry earnings continued to remain strong despite falling energy prices. The sector’s P/E stands at 9x and trades at a 34% discount to its historical multiples.
- The utilities (FUTY) have “attractive dividends and could potentially even increase payouts further,” analysts said, and they believe it could work with regulators to increase payouts “as they seek new capital to fund infrastructure development needed for energy transition”. which includes electricity grids, green hydrogen projects or energy storage facilities.
- Finally, because renewables are lagging, they may trade better in the future, according to analysts at JPM. The cost of financing for the subsector may peak and decline in the coming quarters. Additionally, power purchase contract prices have increased, helping the industry’s profitability.
These are some of JPM’s European picks in the sector:
- Energias de Portugal SA (OTCPK:EDPFY)
- SSE Plc (OTCPK:SSEZF)
- Energia SpA (OTCPK:ENLAY)
- Engie SA (OTCPK:ENGIY)
- E.ON SE (OTCPK:EONGY)
- Centrica Plc (OTCPK:CPYYF)