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Post: : How fast utilities recover from hurricanes like Ian can tell you which of their stocks is best

Nearly 2 million electricity customers across Florida remained without power Friday, a modest improvement from the day before as the state looks to recover from Category 4 Hurricane Ian, a storm tagged as one of the worst ever to hit that part of the U.S.

In a Friday alert, there were 1,933,573 customers without power statewide, reflecting 17% of all customers, according to the state’s Public Service Commission.

For at least one fund manager dedicated to picking attractive utility stocks, how publicly-traded and highly-regulated companies prepare for and quickly react to storms like the powerful Ian can be one valuable test for selecting individual utility stocks, mutual funds or exchange-traded funds that draw heavily from the sector, to round out a portfolio. Utilities are often sought out for their dividends.

Read: Lost Sanibel causeway and ‘reversed’ Tampa Bay: Why Ian will rank among worst hurricanes in Florida history

“There is no doubt [Florida’s] electric system has suffered serious damage and that customers will be without power for a significant amount of time. That said, residents should draw some solace that we believe the NextEra

-owned Florida Power & Light is the best managed utility in America, particularly as it pertains to storm recovery,” said John Bartlett, president of Reaves Asset Management. NextEra was down some 1% Friday and trades about unchanged from where it stood a year ago.

Fatalities and property damage were still being assessed, with many Floridians cut off by flood waters. Ian was recategorized as a hurricane as it moved into the Carolinas on Friday.

“Florida Power & Light has also been a national leader in investing to improve system resilience. It is circumstances like this in which utilities can demonstrate the value of that spending: faster recovery time and a potentially lower storm damage expense bill charged to ratepayers,” said Bartlett.

“Over the last five years, FPL’s track record has been excellent in this regard. It will be very interesting to see just how quickly they can recover. The stock market does not seem to be worried at this point. We share the market’s confidence,” he said.

The utility is also trying to be transparent about the challenges.

“Hurricane Ian’s catastrophic winds will mean parts of our system will need to be rebuilt — not restored. Be prepared for widespread, extended outages as we are assessing the damage. We are already at work restoring power where we can do so safely,” Florida Power & Light said in a release to its customers.

With a utilities focus, Bartlett and team run the Reaves Utility Income Fund
which is down roughly 9% from where it stood at this time last year. It has a dividend yield of 7.7%. The S&P 500

is down 16% in the same span. Meanwhile, the Virtus Reaves Utilities ETF

is down 3.6% year to date but up 4.5% from where it stood one year ago.

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The Fed and the IRA: Other factors to consider

Historically, because investors often buy utilities for their dividends, the Federal Reserve’s interest-rate hikes meant to stymie inflation can put comparable income generators like bonds in higher demand over utilities in a rising-rate environment. What’s more, inflation can cause utilities’ costs to outrun their revenue. That’s why it’s important to differentiate stock names within the broader sector. Investors might ask, for instance, does the regulatory body tied to a particular utility allow that utility to raise rates enough to pass higher operating costs on to consumers?

There’s also a relatively new “screen” for utility stock-picking tied to the Inflation Reduction Act, with plenty of climate change and energy provisions, passed in late summer. It earmarks federal dollars that can improve the economics for solar and wind power

generation and battery storage projects — for households but also manufacturers and the utilities themselves.

The IRA features $370 billion in spending and tax incentives on clean energy provisions. These provisions are intended to spur investments not only by traditional energy and utility companies but also by companies in adjacent industries, like transportation, real estate and manufacturing. The IRA includes significant enhancements if the projects meet certain wage, domestic manufacturing, or location requirements. It also imposes a fee on methane-related emissions and includes various other excise taxes. In all, it means that the economic health and flexibility of select utilities as they address these changes will matter for their long-run standing.

Bartlett told MarketWatch at the time of the IRA passage that the law added to his general bullishness for utilities, with some picks in favor now over others, even in this rising-rate environment.

“Utilities exist to be a public service, right? And so, as a practical matter, they’re sort of the most malleable thing that the government has to implement its environmental policy,” he said. “Top of mind are the tax credits, but more importantly, the transferability of tax credits. This is not money in the utilities’ pocket. But it makes it cheaper for all utilities to build out renewable resources and in the end, it enables utilities to give their customers what they want at a cost that is lower than it would have been without the law.”

The transfer effectively enables utilities to bypass tax equity markets to utilize the subsidies. Currently, many renewable developers partner with banks, which use their tax equity to realize the full value of the credits. But partnering with financial institutions has relationship downsides for power companies. The new transfer allowances essentially creates a new market for the utilities to operate in themselves.

“So now the tax credit is transferable so a utility could sell it to a highly profitable enterprise who wants the tax offset,” said Bartlett, adding that it’s yet another factor that underpins his bullish view of utilities broadly.

Additionally, the new law essentially evens up the tax benefits for the solar power a utility might build or buy to what historically has favored wind.

Which utilities jump on the incentives and smartly frontload capital spending for the inevitable future of electricity will matter. Before the IRA, a slow transition was in the works, but with up to $30 per megawatt-hour production tax credits and up to 50% investment tax credits available for renewables and storage, there’s a clear economic argument for early action, said Dan Esposito, senior policy analyst in Energy Innovation’s Electricity Program, and Kimani Jeffrey, an intern with the program, writing in a commentary.

“Many states and utilities have committed to 100% clean electricity by 2050, but few have pledged meaningful near-term emissions reductions. That can now change — IRA funding makes states and utilities maximizing clean energy by 2030 a smart economic decision, bringing the United States’ climate goals within reach,” said Esposito.

The IRA also contains other tax credits that can benefit public utilities, such as a tax credit for electricity produced in a qualified nuclear power facility, as well as $250 billion in loans that utilities can tap to exit out of coal.

Bartlett said Constellation Energy
the largest operator of nuclear plants, is a prime example of a utility benefitting from federal action, and a stock held by his company. “This really changes the whole story for them,” he said.

It’s called ‘transition’ for a reason

Because renewables are more capital intensive than existing and new fossil fuel infrastructure, building new renewables also empowers utilities to increase returns through the energy transition. As one example, Morgan Stanley researchers found that coal-heavy utility stocks have major potential for revaluation if utilities embrace near-term “coal to clean” investment strategies. New direct pay and transferability options will make it even easier to develop clean energy projects, Esposito and Jeffrey said, in agreement with Bartlett.

But what’s very clear: not all utilities are created equally and there will be growing pains that come with the energy transition.

Dominion Energy

in recent weeks announced an a large offshore wind investment in Virginia, a project whose basic premise cheered Bartlett.

“That’s a huge win for ratepayers, because obviously it takes out the [energy source] volatility and we’re less dependent on carbon because they’re putting in all this offshore wind,” he said. “But it’s also great for utility owners, the shareholders, because we’re converting fuel expense into capital.”

In a recent earnings call, however, Dominion cast some doubt on the project after regulators handed down a ruling that requires Dominion to guarantee that the wind farm lives up to the company’s expected generation projections. If there’s a shortfall in generation capacity, Dominion would be required to bear the cost burden.

Bartlett sees differentiators within the utilities sector, driven perhaps by the response to Ian or any of the other storms that are intensifying with warming oceans, or, set apart based on the potential pain points within the energy transition. All told, however, he remains bullish on what a new look for U.S. power generation will bring.

“We love stability, and our idea of a good time is a company that you know, yields 3.5%, that can raise its dividend 5-6% a year and get you into the highest single digits,” he said.

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