XLU: Why 2019 Was An Anomaly For Utilities

Summary

• Utilities sector (XLU) had an exceptional 26% return in 2019, the highest in 5 years on steady earnings growth and lower interest rates.
• XLU's dividend yield crossed under the energy sector's (XLE) for the first time in history, while reverting to a long-term average relative to 10-year Treasury yield.
• XLU is fairly valued relative to bond yields and other S&P sectors based on dividend yield, return-on-equity and price-to-book ratio.
• Many of XLU's top 20 holdings had flat or negative revenue growth as lack of pick-up in electricity consumption continues to dampen the utilities sector.
• Another year of outsized gain hinges on interest rates declining further, which appears to be highly unlikely.

As 2019 drew to a close, the utilities sector (NYSEARCA:XLU) was in the spotlight after Bloomberg made an interesting observation that utilities' dividend yield dropped below the energy sector's (XLE) dividend yield, "flipping a decades-long relationship" in the process. To wit:

The inversion of these two sector yields means that what was once priced as growth is now priced as value, and vice versa.

The author has a point regarding the growth story between the two sectors, as XLU's dividend payout has grown for 9 consecutive years while XLE's has been uneven at best since peaking in 2015:

Indeed, although the annual growth rate has been in the single digits, on aggregate, XLU's dividend payout growth in the last 5 years outpaced XLE's by 6%:

TTM Dividend Payout	XLU	XLE	XLU YoY Growth	XLE YoY Growth
2010	1.272	0.997	-0.08%	-3.58%
2011	1.368	1.061	7.55%	6.42%
2012	1.445	1.301	5.63%	22.62%
2013	1.466	1.527	1.45%	17.37%
2014	1.506	1.859	2.73%	21.74%
2015	1.59	2.044	5.58%	9.95%
2016	1.659	1.701	4.34%	-16.78%
2017	1.752	2.191	5.61%	28.81%
2018	1.761	2.03	0.51%	-7.35%
2019	1.908	2.243	8.35%	10.49%
			XLU	XLE
3-Year Growth			15.01%	31.86%
5-Year Growth			26.69%	20.66%

Click to enlarge

In 2019, XLU's dividend payout actually grew at the highest clip of the decade, which along with the renewed plunge in bond yields contributed to XLU's best performance since 2014. In terms of its relative value with bonds, the spread between XLU's dividend yield and 10-year Treasury yield rebounded from zero all the way to just under the long-term average of 1.2%:

In other words, after turning the most overvalued relative to bonds in a decade, the steep decline in 10-year Treasury yields completely reversed the narrative as the utilities sector is now fairly valued according to its historical yield differential

Analyst’s Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.