3 Stocks to Consider When Rates Rise

Central banks on both sides of the U.S.-Canada border have indicated higher interest rates are coming soon. Recent public announcements by both Bank of Canada and U.S. Fed included language that implied the days of accommodative policy are over and that there’s need to raise key interest rates to tame spiralling inflation.

While an interest rate hike is widely regarded as a sign of economic strength, and is generally supportive of stock markets, it tends to negatively impact certain sectors. For investors, this means stocks in sectors such as telecommunications and utilities call for a fresh look. The prices of these stocks have an inverse relationship with interest rates. Utility and telecom operations are capital intensive. Hence, these companies need to frequently borrow capital to support growth and build out infrastructure. When interest rates tick higher, the cost of borrowing balloons, which is negative for the following interest-rate-sensitive businesses.

One of the largest utilities in the U.S., (SO) distributes electricity and natural gas to approximately 9 million customers in nine states. It owns 50 gigawatts of rate-regulated generating capacity, serving customers in Georgia, Alabama, and Mississippi. The company admits in a press release that interest rate fluctuations can have a meaningful impact on its financials.

Southern is pivoting towards green energy as part of one of the most dramatic transformations in the utilities sector. “In 2000, almost 80% of the electricity Southern sold to its customers was generated using coal, [however] that share is now down to 20% and falling,” says a Morningstar report. Subsidiary Southern Power Co. owns 12 gigawatts of mostly non-rate-regulated renewable energy capacity and sells the electricity primarily under long-term power sales agreements.

As the company tries to lower its greenhouse gas emissions, the share of nuclear, natural gas, and renewable energy are all increasing. Southern aims to “retire all but eight coal plants by 2028 and reach net-zero carbon emissions from its power generation fleet by 2050,” says Morningstar strategist, Travis Miller.

“The dividend has grown more slowly than earnings in recent years because of Southern's growth investments, including Vogtle, but dividend growth should accelerate to match earnings growth once Vogtle is finished,” says Miller who puts the stock’s fair value at US$64.

U.S. integrated energy behemoth, Dominion Energy (D) generates approximately 30 gigawatts of electric generation. The firm owns a liquefied natural gas export facility in Maryland and is now beginning a 5.2 GW wind farm in Virginia. Dominion is committed to clean energy and is working towards achieving net zero carbon dioxide and methane emissions from its power generation and gas infrastructure operations by 2050.

“After exiting its oil and gas exploration and production business, selling and retiring its no-moat merchant generation, Dominion's investors are left with a predominantly regulated utility,” says a Morningstar equity report, stressing that this “strategic pivot has been in the best interests of shareholders.” Over the next 15 years, Dominion forecasts US$72 billion of capital investment opportunities, including US$17 billion for what is expected to be one of the largest offshore wind farms in the U.S., the report notes.

“Dominion's other growth opportunities include solar, energy storage, nuclear life extensions, electric grid upgrades, and gas distribution modernization,” asserts Morningstar equity analyst Andrew Bischof, who puts the stock’s fair value at US$81.

The utility’s renewable energy portfolio is projected to grow from roughly 4 gigawatts in 2020 to nearly 30 GW by 2035. “These investments support 6.5% annual earnings per share growth,” says Bischof.

Canada’s largest wireless provider, Rogers Inc (RCI.B) boasts more than 10 million subscribers, about one third of the total Canadian market. Rogers' wireless business accounts for 60% of the company's total sales, the cable segment provides about 25% of total sales, while the rest come from Rogers' media unit (various television and radio stations and the Toronto Blue Jays). The company’s also has ownership stakes in other sports franchises including Toronto Maple Leafs, Raptors, FC, and Argonauts.

“In a Canadian telecom industry that was crushed by the pandemic, Rogers was hurt the most because of its greater reliance on wireless roaming revenue and professional sporting events,” says a Morningstar equity report. These headwinds are temporary, however, and Rogers’ fourth-quarter 2021 results show the recovery is well underway. Rebounding from the pandemic hit, the firm’s wireless service revenue grew 6% year over year, driven by 130,000 postpaid net additions and 3% wireless average revenue per user (ARPU) growth. 

However, the biggest opportunity to drive wireless revenue growth will come from the return of roaming, which remains more than 20% below pre-pandemic levels. “We expect omicron to delay roaming growth in 2022, but expect a full recovery to be an ARPU tailwind for the next couple years,” assures Morningstar equity analyst, Matthew Dolgin, who pegs the stock’s fair value at $68.