Interactive Investor

One of the few sectors that still looks cheap

16th December 2020 09:54

Rodney Hobson from interactive investor

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Many industries have seen valuations rise sharply since March, but there is still value here. 

Rodney Hobson is an experienced financial writer and commentator who has held senior editorial positions on publications and websites in the UK and Asia, including Business News Editor on The Times and Editor of Shares magazine. He speaks at investment shows, including the London Investor Show, and on cruise ships. His investment books include Shares Made Simple, the best-selling beginner's guide to the stock market. He is qualified as a representative under the Financial Services Act.

With share price indices in the United States hitting new highs, it is hard to spot worthy sectors that have been left behind in the recovery from the Spring stock market slump. One possibility is to look at energy stocks such as Duke Energy (NYSE:DUK) and Dominion Energy (NYSE:D).

It is possible to argue that Covid-19 has taken a toll on the US economy and that, with the epidemic still raging across many states, there will continue to be an impact on production and employment well into the New Year. This would inevitably reduce demand for gas and electricity and thus hit the profitability of energy companies, which tend to have substantial fixed costs.

However, the same argument would apply across a range of sectors, yet investors have not baulked at pushing the Dow Jones Average above 30,000 for the first time. By all accounts, energy shares are looking comparatively cheap.

And energy is one area where new President Joe Biden has distinct views, ones that will be put into effect from day one of his term of office. He proposes a greener energy policy. That will be a distinct bonus for companies with facilities for renewable energy. 

Duke is one of the largest US utilities, selling electricity and gas to customers in North and South Carolina, Indiana, Florida, Ohio and Kentucky. It also owns energy infrastructure.

Duke is at last marginally ahead of the $90 at which it began the year, having been as low as $64. It did briefly top $100 before the Covid-19 crisis set in and should do again next year, hopefully for a longer period of time.

Source:  interactive investor. Past performance is not a guide to future performance.

Dominion, based in Virginia, is an electricity generator that also owns power lines. It has a liquefied gas facility in Maryland and is building a wind farm off the Virginia coast that will be the largest in the US.

Dominion began the year at $82 and peaked at $90 before plunging to $60. The recovery has twice petered out at $87 and the stock is currently at $76, where the yield is 4.6%, a particularly attractive level for an American quoted company.

Source:  interactive investor. Past performance is not a guide to future performance.

Another possibility in the sector is Southern Co (NYSE:SO), which like Duke is one of the largest utilities in the US. It has generating capacity and also sells electricity and natural gas in nine states. Its wind farms are spread across a number of states in addition to its core market.

Its wholly-owned subsidiary Southern Power generates from mostly renewable energy sources and is the conduit through which the group stands to gain most from Biden’s green agenda.

I recommended the shares at $56 in May last year and all was looking well when they topped $70 in January this year. They have taken a bigger hit than either Duke or Dominion since, slumping to $46 in March and performing disappointingly since. They currently stand just above $60, mercifully back ahead of my tip price, where the yield is 4.3%. 

Source:  interactive investor. Past performance is not a guide to future performance.

Hobson’s choice: When I wrote about this sector in January, I pointed out that Duke had underperformed Dominion during 2019, with the gap widening in the final three months. I described this phenomenon as “quite unjustified” and rated Duke the better value at around $90.

Both companies currently look underpriced. I repeat my January advice to buy Duke up to $93. Its yield of 4.2% is only fractionally lower than at Dominion. I have, however, switched my preference to Dominion, which is worth considering at up to $80, with the downside probably limited to the recent low of $73.50. Southern also looks good at up to the recent peak of $63.70.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.

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We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Where relevant we have set out those particular matters we think are important in the above article, but further detail can be found here.

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