(Bloomberg) — Utilities stocks have become a surprise favorite among Asian investors, raising hopes that this year’s impressive rally will continue.
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After two years of losses, the power sector is booming, driven by supportive local policies and the enthusiasm around artificial intelligence that is driving a dramatic increase in electricity demand around the world.The utility company's high dividends and the defensive nature of its shares are also being touted as tailwinds amid growing concerns about a possible global economic slowdown and rising geopolitical tensions.
The MSCI Asia Pacific Utilities Index is up nearly 14% so far this year and on track to post its biggest annual gain since 2006, second only to technology stocks among the 11 subindexes of MSCI's pan-Asia benchmark.
“It's important to take a step back and think about the broader, transformative drivers of long-term growth in the sector,” said David Smith, senior investment director for Asia equities at abrdn. “In recent years, it has been recognised that growing electricity demand, combined with the demands of the energy transition, will require large-scale, widespread investment in the energy grid and power generation, and in the software that controls the grid.”
Regional factors such as India's robust economy and China's efforts to tackle environmental issues have also contributed to utilities' relative advantage compared to their U.S. and European counterparts and the broader Asian market.
India's power companies, buoyed by a growing population and expansionary fiscal policy, have thrived as supply shortages have pushed up local electricity prices. In Japan, a government plan to speed up the restart of nuclear plants has fueled a recovery among utilities that struggled for years after the 2011 Fukushima disaster.
“It's an election year in the U.S., while Asian countries have strong fiscal balances and political willingness to spend, so spending on power and infrastructure is not a priority,” said Brittney Lam, head of long/short equities at Magellan Investments Holding Co. “As we move towards rate cuts, the focus will be on cash flow and dividend yields.”
“Very exciting”
Among the leading stocks in MSCI's Asia utilities subindex, India's NTPC, Power Grid Corporation of India and Japan's Kansai Electric Power Co. are all up nearly 30% or more this year. Top gainers including Malaysia's YTL Corp, India's Torrent Power and China's CGN Power have all surged more than 50%.
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“India is a very exciting place right now when it comes to the theme of utilities and broader grid capital investment,” said abrdn's Smith. “It has clear and visible investment in the grid, an ambitious target of growing renewable energy capacity to 500GW by 2030, regulatory and policy continuity, and some high-quality, well-managed companies that could take advantage of this.”
Utilities have also been popular in China as a weak economy and sluggish stock market have seen investors flock to high-dividend defensive stocks, while the Beijing government's ambitious climate goals and ongoing power market reforms have also brightened the sector's outlook.
These measures are expected to “streamline the pricing mechanism of utility charges, reshape asset values such as water, electricity and waste disposal, and stimulate the vitality of green consumption through further institutional reform and innovation,” analysts at Topsperity Securities including Guo Lei wrote in a note.
The utilities subindex has risen about 27% so far this year, making it the best performing part of China's CSI 300 index. The broader benchmark is down 2.5%.
Investors are also turning to utility stocks in South Korea and Malaysia as the global AI boom boosts demand for data centers. South Korea's HD Hyundai Energy Solutions has risen 9% this year, while Malaysia's YTL has soared 85%. An Asian stock index has risen 7.8%.
Indeed, there is growing skepticism about potential hype and bubbles surrounding this new technology, as evidenced by the sharp drop in major AI stocks since late July.
“It's very hard to gauge the power demand from AI because you need to know how much these companies use display cards and other devices,” said Kelvin Ng, an analyst at Bloomberg Intelligence. He also warned that profit growth for utilities in Asia excluding India will be “very modest” over the next three to five years.
But for many market participants, uncertainties related to the global growth outlook, Middle East tensions and the U.S. presidential election give them reason to expect the defensive utilities sector to fare better as market volatility increases.
“As China and the U.S. both cut interest rates, these high-yielding utility stocks become more attractive from a dividend yield differential perspective,” said Dennis Yip, an analyst at Daiwa Capital. “Hong Kong utilities and Chinese hydropower stocks will be safe havens.”
–With assistance from Chiranjivi Chakraborty.
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