The XLU Buy Thesis: Cheap And Better Growth

Core Viewpoint - The utilities sector has become opportunistically cheap with strong growth potential and a significant price drop, suggesting that the Utilities Sector ETF (NYSEARCA:XLU) will outperform the broader market while providing defensive benefits in a weakening economy [1] Sector Performance - Utilities fell almost 5% last month despite a 30 basis point drop in interest rates, breaking the typical inverse relationship between utilities and yields [2][5] - Utilities are currently trading at a forward multiple of 18.1X, which is a substantial discount compared to the S&P 500's 30X trailing earnings and 22.1X forward multiple [9][11] Growth Potential - Utilities are forecasted to grow revenue by 6.4%, slightly above the S&P 500's 6.1%, and earnings growth is expected to be 16.6%, significantly outpacing the S&P 500's anticipated 11% growth [13][15][16] - Independent power producers (IPPs) are experiencing temporary growth rates of 70% due to a spike in auction energy prices, while regular electric utilities are growing at 15% [15] Valuation Mispricing - Utilities are undervalued relative to the broader market, with faster growth rates and lower multiples, which typically suggests higher risk; however, utilities are considered reliable businesses with consistent earnings growth [17][18] - The current discount of 4 turns on forward earnings multiple is unwarranted given the improved growth rate of utilities, which has surpassed that of the S&P 500 [25] Defensive Sector Outlook - The utilities sector is expected to benefit from anticipated interest rate cuts, with projections indicating a Fed Funds rate of 350-375 basis points after December [21] - A further decline in Treasury yields could redirect dividend investors' capital into the utility sector, enhancing its attractiveness [23] Investment Opportunities - The XLU ETF has significant holdings in IPPs, which may be overvalued; however, the sector overall remains cheap, with an average earnings multiple of 17.4 among tracked electric utilities [24][26] - Companies like Dominion (D), American Electric Power (AEP), and Pinnacle West (PNW) are highlighted for their strong fundamental positioning within the sector [27] Conclusion - The utilities sector presents a unique opportunity as it combines reliability, moderate growth, and value, making it an attractive investment option [28]