Is A Fed Tightening Good For Water Utilities? This Analyst Thinks So

Courtesy of Benzinga.

In a report published Friday, Boenning & Scattergood analyst Ryan Connors argued that a rising rate environment is a positive for water utility stocks and that the group delivered some of its best relative performance during past Fed tightening cycles.

“The two key reasons why water utilities have defied the utility/rising rate maxim are that (a) because benchmark interest rates are a key component in determining awarded ROEs, fundamental returns in the space are actually positively correlated with interest rates, and (b) public utility commissions often seek to minimize rate increases (and hence ROEs) during periods of economic duress and “loosen the reins” as the economy improves (and monetary policy tightens),” Conners wrote.

Conners offered two key points to expand the thesis. First, utility commissions use benchmark interest rates as a key factor in their ROE formulas, resulting in a positive correlation between ROEs and interest rates that has driven downward pressure on returns in recent years. Second, water is a basic necessity and utilities are more averse to raising prices when the middle class is struggling. The analyst argued that job growth is now “accelerating” and the outlook for middle class households “much improved,” public utility commissions are likely to become more “accommodating.”

The analyst expanded that this is a timely issue for shares of American Water Works Company Inc (NYSE: AWK) as the Fed looks to embark on a tightening cycle. The company is expected to hit the high end of its targeted 7 percent to 10 percent earnings per share growth rate in a rising rate environment.

Shares are Outperform rated with a $58 price target.

Posted-In: Boenning & Scattergood Fed Interest Rates Ryan Connors UtilitiesAnalyst Color Analyst Ratings