The Federal Reserve’s (the Fed) decision to cut interest rates often triggers a surge in investor interest towards sectors expected to outperform due to historical trends and fundamental reasoning. However, this rate cut presents a unique scenario, as the US economy navigates a more globalized and slower landscape than in recent years. This shift creates a new case study, one where factors like rising credit card delinquency rates and spiking car repossessions could act as headwinds for the consumer discretionary sector, despite the interest rate cuts. At the same time, the energy sector might experience slower growth due to easier financing rates, especially after the 22-month contraction in the manufacturing PMI index, which indicates a decline in business activity. Adding to the complexity, the dollar currently enjoys a strength comparable to its peak during the COVID-19 pandemic. Given these intertwined factors, investors should prioritize the impact of interest rates on company fundamentals rather than solely relying on consumer or economic impacts, as these may be less clear-cut in the current environment.
Focusing on company fundamentals, it’s crucial to examine balance sheets, particularly how lower interest expenses can impact utility stocks like Dominion Energy Inc. (D) and dividend real estate investment trusts (REITs) like Brookfield Infrastructure Partners (BIP).
Why Utility Stocks Thrive in a Low Interest Rate Environment
Utility stocks typically carry higher debt levels compared to other industries, resulting in greater interest expenses on their income statements. Lower interest rates significantly benefit these companies by reducing their interest expenses, directly boosting earnings per share (EPS). Since stock prices are intrinsically linked to earnings, investors can recognize the domino effect of lower interest rates on the utility sector, particularly if the underlying stocks and their balance sheets have sufficient debt to amplify this impact.
Dominion Energy serves as a prime example. This utility stock carries up to 61% debt on its balance sheet, making it highly susceptible to the positive effects of lower interest rates. Its earning power is expected to experience a substantial boost. Currently trading at 98% of its 52-week high, Dominion Energy has witnessed market appreciation exceeding that of even the S&P 500. Moreover, this stock offers an attractive dividend yield of 4.6% annually, surpassing the Fed’s target inflation rate by a factor of two. With a subscription-based business model, utility stocks like Dominion Energy provide safer and more predictable cash flows, mitigating potential market volatility.
Wall Street analysts are projecting an EPS of $0.75 for Dominion Energy within the next 12 months, representing a significant increase from the current $0.65 per share, or a 15.3% jump. Based on these positive projections, Jefferies Financial initiated coverage on the stock, valuing it at $58 per share, which aligns with its current trading price. However, this could change soon. Despite the fundamentally bullish trend, short interest in Dominion Energy has declined over the past quarter, suggesting a bearish capitulation among investors. This reinforces the positive outlook for the stock.
Low Interest Rates Enhance Rental Income Potential in Dividend Real Estate Stocks
Lower interest rates also fuel the income potential of property stocks, particularly REITs like Brookfield Infrastructure Partners. These companies benefit from increased financing rates and liquidity, enabling them to acquire new properties and expand their real estate portfolios. These acquisitions generate higher income from tenants and contribute to the appreciation of the newly acquired properties, resulting in further upside potential. Brookfield Infrastructure Partners’ balance sheet reveals a debt level of 64.3%, mirroring the impact on utility stocks. Lower interest expenses translate into enhanced earning potential. Wall Street analysts project an EPS of $0.84 for the next 12 months, a substantial increase from today’s net loss of $0.10 per share. This potential profit growth empowers management to offer an attractive dividend yield of 4.8%, with the potential for further increases as lower interest rates enable the company to expand its property income. Analysts have established a consensus price target of $37.6 per share, representing an 11.1% upside from the current stock price. Considering that Brookfield Infrastructure Partners is currently trading at its 52-week high, analysts anticipate a potential new high for the stock, aligning with the bullish sentiment surrounding the stock and the sector.
