Why TSX Utility Stocks Look Appealing Right Now

TSX utility stocks will likely outperform this year given the impending recession and steady rates.

| More on:
The sun sets behind a power source

Source: Getty Images

The Canadian markets are up 5%, while the S&P 500 has soared 10% so far in 2023. It’s interesting to see how equities are holding strong even amid the rising recession fears and unending macroeconomic uncertainties. However, considering an impending economic downturn and ensuing interest rate cuts, one pocket looks quite appealing—utilities.  

Utility stocks outperform in market downturns

TSX utility stocks are well-placed to ride through a recession. And that’s because of their stable earnings profile. Utilities are often called “widow-and-orphan” stocks because of their stable dividends and less volatile stocks. However, they have notably outperformed in bear markets. For example, when the broader markets crashed by more than 30% in March 2020 amid the pandemic, TSX utilities at large corrected only by around 15%.

As markets take an ugly turn amid the economic downturn, investors take shelter in defensives like utilities. The less-volatile stocks protect capital, generating a decent amount of passive income at the same time.  

Canada’s top utility stock Fortis (TSX:FTS) has seen several downturns in the past and has emerged even stronger. It derives almost its entire earnings from regulated operations, enabling stable dividends. CU stock currently yields 4%, higher than TSX stocks. It has increased shareholder dividends for the last 50 consecutive years. Such a long payment streak indicates stability and reliability.

Utility stocks outperform when interest rates decrease and vice versa. So, as rates turned higher, TSX utility stocks notably underperformed last year. But since rates might hold steady or move lower going forward, utility stocks will likely surge higher. Bonds will become less attractive in the falling rate environment, making utilities more appealing.

Another factor is improved profitability. Utilities are a capital-intensive business and they generally carry a large amount of debt. So, as interest rates fall, their debt servicing costs also fall, ultimately improving their bottom line.

High payout ratios and stable profitability

Canadian Utilities (TSX:CU) is another safe and reliable dividend-payer name investors can consider. It has increased its net income by 2% compounded annually in the last decade. That’s much lower compared to broader markets. However, utilities keep growing steadily even in recessions, thanks to the stable demand for their services.

Another differentiating factor about utilities is their high payout ratios. They give away a big portion of their earnings in the form of dividends. For example, it is common for utilities to have a payout ratio of around 70%–80%, whereas the broad market average is around 20%. Canadian Utilities distributed 85% of its earnings in dividends last year.

Conclusion

If a recession occurs in the near future, fast-growing sectors like tech and consumer discretionary will bear an oversized brunt of the downturn. That’s because their earnings have a high correlation with economic cycles. However, defensives like utilities will likely outperform. Stocks like CU and FTS offer a decent low-risk, moderate return proposition, which will stand tall in volatile markets.   

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

The Motley Fool recommends Fortis. The Motley Fool has a disclosure policy. Fool contributor Vineet Kulkarni has no position in any of the stocks mentioned.

More on Dividend Stocks

Hands holding trophy cup on sky background
Dividend Stocks

3 of the Top Dividend Stocks in Canada

Top TSX dividend stocks are still on sale.

Read more »

man touches brain to show a good idea
Dividend Stocks

Pembina Vs. Brookfield Renewable: Which High-Yield Dividend Stock Is Better?

Both Pembina Pipeline (TSX:PPL) and Brookfield Renewable Partners (TSX:BEP.UN) look like strong dividend stocks, but is one better?

Read more »

Pile of Canadian dollar bills in various denominations
Dividend Stocks

Invest $20,000 in 2 TSX Stocks for $863/Year in Passive Income

Shares of these two fundamentally strong Canadian companies can help you start a worry-free passive-income stream.

Read more »

Dividend Stocks

The Best Canadian Stocks to Buy With $1,000 Right Now

If there are just three Canadian stocks you can pick up with $1,000, make them these three. All have dividends…

Read more »

Growing plant shoots on coins
Dividend Stocks

2 Incredible Dividend Growers to Buy Hand Over Fist in July 2024

These two top Canadian dividend stocks, with solid track records of raising dividends, look really attractive to buy right now…

Read more »

sale discount best price
Dividend Stocks

3 Discounted Stocks to Track in July 2024

Not all discounted stocks are worth buying right away. You have to watch many of them to recognize the trend…

Read more »

The TFSA is a powerful savings vehicle for Canadians who are saving for retirement.
Dividend Stocks

How to Use a TFSA to Earn $250 per Month in Tax-Free Passive Income

Looking for long-term growth in your TFSA? Here is exactly how to create the perfect passive income portfolio, and where…

Read more »

Hand writing Time for Action concept with red marker on transparent wipe board.
Dividend Stocks

3 Reasons to Buy CAPREIT Stock Like There’s No Tomorrow

CAPREIT (TSX:CAR.UN) has proven its worth time and again. And after strengthening its portfolio, it could be time to pick…

Read more »