Sell Utilities And Buy Companies Utilities Pay

Two months ago, I suggested there were 3 Headwinds For (The) Summer Stock Market:

  • Seasonality
  • Slowing economic growth
  • Trade disruptions

So far, those headwinds have resulted in a minor correction.

It’s during these corrections, if you were wise enough to raise some cash ahead of time, or have regular cash flow to invest, that you want to become a contrarian buyer of stocks.

Mind you, I’m not saying dive in because the stock market is down a few percent. We want to continue to mind market signals and sentiment. This correction doesn’t appear to be over to many of us.

When the correction is over though, we will want to have shopping list of stocks to buy for the inevitable rebound. That shopping list needs to be forward looking.

Don’t Buy “Grandpa Stocks”

Last summer, I gave an interview and told folks to dump their “grandpa stocks.” This was met by some pretty amusing vitriol from those who love their high debt, low growth dividend payers. They actually used the word “love” and said I was the crazy one.

Here’s what I know. While dividends often signify a worthwhile business, my screening suggests that fully one-third of dividend payers are at risk of dividend cuts in the next recession. Companies with no growth or shrinking markets, that also have high debt are the most at risk. Expect those stocks to get destroyed.

Many utilities have a special problem. The transition to alternative energy is now past batting practice. We recently saw a decision to tear down a coal fired power plant in favor of building a solar and wind farm with batteries for storage. That happened in Indiana, a norther clime and the state that uses the most coal as a percentage of energy generation.

Over the next decade, utilities will need to engage in a massive capital cycle as they upgrade the grid and buildout new generation facilities. Ultimately, I believe utilities will be the fulcrum to a renewable energy economy and enjoy very sustainable profitability. But, for a while, those stocks, which are at historically very high prices, will see their margins contract significantly and debt rise. It is not hard to see those stocks falling 30-50% in the next few years.

Buy Sustainable Dividend Stocks

There is a notion that stocks associated with sustainability are primarily growth stocks. That is only partially true. Growth is the component that drives all stocks. A company cannot raise its dividend organically, i.e. without financial engineering, without growth. The best growth stocks have a sustainability angle.

Sustainability stocks are simply those from companies that have made a real commitment to sustainability – not a faux press release and power point presentation for investors. The best sustainability stocks are of the companies that help other companies, the public and the government attain sustainability. Let’s focus on those companies for a few paragraphs.

If utilities are going to struggle soon, where then can we find utility like dividends. The answer might be companies that help the utilities in their transition to renewable power generation and smart grid.

One such company could be Albemarle Corp. (ALB) which is the world’s largest lithium producer. The company is based in North Carolina, but has its mining operations in Chile and Australia, as well as, in the U.S. To transition to renewable energy, utilities will need what Albemarle produces. Right now, that is lithium. A recent announcement suggests that they will at least joint venture, though might go it alone, to produce batteries near their mineral deposits. This would cut the costs of batteries even more than technology is doing now. That would result in another profit surge for the company.

Albemarle stock has tumbled over 60% in the past 2 years. I believe the collapse is largely driven by a manic attack on anything climate change related by the U.S. administration. Maybe it was just a normal pullback after a rally. It doesn’t really matter. The stock is cheap, growing, profitable, has a great outlook and pays a 2.2% dividend.

Cisco (CSCO) is another company that is involved in the utility space, but is not a utility. It is helping utilities improve systems, drive efficiency and adapt to the new realities of a smart grid.

Cisco shares have had a small pullback in the past couple months and yield about 2.5%. The company is increasing buybacks and dividends regularly. It’s middle single digit growth rate isn’t super exciting, but given lower growth rates in among utilities. Cisco is also on net, debt free, with $34 billion in cash and short-term investments against $23 billion of long-term debt. Compare that to NextEra Energy (NEE) which has a similar growth rate, but only a billion in cash and long-term debt of $40 billion (hint: it’s time to sell NextEra and many other utility stocks).  

Buy Sustainable Growth Stocks

The solar industry is where most people think of sustainable growth stocks. Many cry about a past of no profitability. And that was legitimate then. It’s not now. Solar and solar related companies are becoming more profitable by the quarter and that is accelerating.

I told you about First Solar (FSLR) about six weeks ago.  The company is profitable, net debt free and growing. It is a major beneficiary of utilities switching largely to solar as the leading utility scale solar developer in America. If utilities are going to lead the transition to renewable energy, and all signs are they will, then First Solar will be a huge beneficiary over the next decade.

First Solar has rallied off of its lows, and been in choppy channel the past six weeks. It has strong support around $50 per share and another major support level around $35 per share. I’m not sure it will get to the $35 level, but with just normal volatility, I can see around $50 per share easily. That’s a buy point for me.

Two other solar stocks to buy share a duopoly in microinverters and power optimizers. These are the essential components that bring energy from the solar panel to the battery or grid. Enphase (ENPH) and SolarEdge (SEDG) share most of the business in American and have substantial international business.

Enphase struck a very important deal with SunPower (SPWR), which is the leader in commercial solar development, on technology and to be SunPower’s exclusive microinverter supplier. It is pursuing deals with international players to continue expanding around the globe. It’s next generation technology and storage solutions are generating large growth.

SolarEdge has been the leading module provider for residential energy systems. It is now expanding to larger systems, including commercial and utility. Its software solutions are aimed at the smart grid. The pairing of hardware and software is a model that nobody has duplicated yet. The company has diversified into EV chargers and uninterruptible power supply to reduce volatility and risk.

Between Enphase and SolarEdge’s technology and service spread, these two companies dominate the market for taking energy from the solar cell to end points. In my mind it makes sense to own both. If either runs away, while the other falls, then adjust then. I think it more likely both are very successful, but it is hard to determine which will be more successful just yet.

SolarEdge shares are off about 20% from all-time highs set in 2018, but have rallied recently. Enphase is back from the dead and up over a 1000% in the past couple years. It’s been choppy lately, but sits near its all-time high set in 2014. I would be looking to buy both on pullbacks. SolarEdge looks attractive in the middle $40s to me. Enphase looks about right around $11 or $12 per share. There could be substantial breakouts for both when they set new all-time highs.

I mentioned SunPower above. They are also interesting, and I will cover them later.

It’s Time To Move Forward As Investors

I understand that investors are wary to change paths, especially paths that have been successful in the past. However, what is truly successful over and over, is buying growth stocks on pullbacks. Some growth stocks pay a dividend. That’s great. But, the underlying growth is what allows it.

With utilities entering a stage of transition that will require massive capital outlays and their stocks sitting at multiyear highs in many cases, it is time to harvest those profits and move on. To benefit from the security of the utilities, it now makes sense to invest in the companies that utilities will be sending money to over the next decade.

Albemarle, First Solar, Cisco, Enphase and SolarEdge are all companies that are benefitting and will continue to benefit from the emergence of economic alternative renewable energy, the smart grid and energy storage. Look there to rotate your utility allocation.