Utility stocks are shares of companies that provide a public service—such as electricity, gas, and telephone companies. These companies tend to resist most economic downturns, since demand for these products is unlikely to fall during a recession.
However, utility stocks are subject to other risks, especiallychanges in interest rates. Read on to find out how utility stocks are affected by interest-rate risk.
Key Takeaways
- Utility stocks are typically considered defensive stocks—they tend to stay profitable during a downturn.
- However, utilities are subject to other risks, including interest rate risk.
- Utility stocks have many of the same benefits as bonds—so an increase in interest rates could make bonds more attractive.
- High interest rates also increase the costs for utilities, which often carry high levels of debt.
Competition With Bonds
First, an interest-rate increase makes bonds look more attractive to conservative investors – the very type who are typically drawn to the utilities sector stocks.
For example, following the financial crisis of 2008 and the resulting sustained near-zero interest rate environment, utility companies benefited by drawing the attention of many conservative, income-focused investors; with bond yields at such very low levels, the average dividend yield of utility companies, which was around 4.8%, offered an attractive alternative. However, if interest rates and the corresponding yields available on debt instrument begin to rise, utilities will likely lose some investors to the bond market.
$1.1 trillion
The total revenues of the U.S. utilities sector in 2023.
Interest Rates and Debt Levels
The second way interest rates impact utility companies is by increasing their borrowing costs. Of course, an interest-rate hike affects all businesses this way, but it’s an especially important factor for utility companies because of their typically high debt levels. Major utility firms have major capital expenditures and high debt-to-market cap levels. The construction of power plants and the maintenance of the vast infrastructure required to deliver gas, water, or electricity makes utilities a very expensive business that requires major debt financing.
Utilities have benefited from cheap financing rates in recent years, but a significant rise in interest rates would change that. Some utility companies can offset their increased borrowing costs by passing them on to customers, but being able to raise their rates enough to cover the extra cost of financing is not a given. If companies are unable to pass on the extra costs to their customers, these costs are at least partially borne by their equity investors and bondholders, thus making the companies less attractive to new investors.
Why Are Utilities Considered Defensive?
Utilities are considered defensive stocks because they tend to resist economic downturns. Because consumers are unlikely to stop consuming these products (electricity, water, telephone, and internet access), these stock prices are less sensitive to changes in consumer discretionary income.
What Are the Disadvantages of Utility Stocks?
While utility stocks show steady returns during a downturn, they also cannot match the returns of cyclical stocks during an upswing. An analysis of utility stocks by Edward Jones found that utilities performed weakly in 2023, and although their performance increased in 2024, they still did not match the price-to-earnings ratio of the wider market.
What Are the Biggest Utility Companies?
The list of the world’s biggest utilities by revenue is led by France’s Électricité de France SA (EDF), Italy’s Enel SpA, and Germany’s E.ON. In the U.S., the largest is Exelon Corp. (EXC).
The Bottom Line
Utility stocks are attractive for investors who fear a market downturn. However, these companies are more susceptible to interest rate risk. Since utilities tend to have high debt levels, a high interest rate could significantly impact their bottom line. Moreover, high interest rates could also buoy the bond market, which is a leading competitor with utility stocks.