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Should you consider utility stocks like AGR to hedge downside risk?

You don’t have to be an active investor to have heard about the market’s rapid plunge into bear market conditions as COVID-19 reached pandemic levels, forcing global shutdowns, quarantines and shelter-in-place orders. If you do watch the market closely, then you’ve certainly noticed the market’s rebound from a bear market bottom in late March; in the case of the NASDAQ 100 index, for example, the rally has been sizable enough to push the index nearly to its February high. That sounds like a tempting reason to accept the notion that the recovery has begun and the worst is over.


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The market’s rally, however, flies in the face of other clear indications that the actual economic recovery is going to take much longer. This week’s unemployment report, for example seems to make it clear that while in some ways the labor market might be improving – the number of continuous claims was a bit lower, meaning that people who have been claiming unemployment for more than one week actually dropped – there were still more than 2 million new unemployment claims in the last week, bringing the total number to more than 40 million. That’s a big number, and it’s a good indication of the unfortunate reality that for many people who were temporarily laid off or furloughed with the expectation of returning to work at some point in the future, those job losses may become permanent.

For every indication of America’s resilience and adaptability in the face of adversity – think of the way corporate America has managed to shift many white-collar jobs into a functional, work-at-home model – there are other indications of long-lasting impacts. In the case of work-at-home arrangements, there are reports that many corporations are planning to make that shift a long-term arrangement, and in some cases, even a permanent one. While that means the preservation of jobs and has a number of other positive effects for that business, it also has ripple effects. Think, for example, of the restaurants and other small businesses that may be located near to corporate offices, and who have relied on the corporate lunch crowd for major portions of their revenues. Long-term work-at-home plans, or even modified in-office plans that include social distancing measures and perhaps an alternating, in-office/at-home work arrangement will undoubtedly have an impact on the ability of those small businesses to survive.

I’m not outlining grim details to simply paint a bearish picture; the truth is that I hope that a gradual, measured approach to resuming normal activities – social, business, and otherwise – is successful in achieving the delicate balance between restarting the economy and managing health risks. I think it is foolish, however to simply “hope for the best” and simply ignore downside risks. If a true economic and health recovery is going to be as some (including myself) expect, a long-term proposition, that implies that the market is once reaching pretty overpriced levels, and could be over-anticipating the best-case scenario. If you’re a conservative investor, that means that the smart thing to do is to keep looking for conservative ways to keep your money working for you.

Among the sectors of the economy that are considered “defensive” – those that tend to be resilient even when the economy struggles – utilities often lead the way. Utility companies are an interesting lot to analyze; they often operate with razor-thin margins and high levels of leverage as they continually invest in maintaining and improving their own infrastructure. They also generally have pretty stable cash flows and revenues, since the public always needs electricity and natural gas – not only for heat during cold winters, but also for basic power needs and air conditioning during hot summer months. These are also companies that also usually pay healthy, higher-than-average dividends, providing an attractive passive income source along the way.

Avangrid Inc. (AGR) is a mid-cap utility company that operates primarily in the Northeast area of the United States, servicing about 3 million customers between electric and natural gas services. This is a stock that dropped with the rest of the market from a February peak at around $57 to a low point in March at around $37.50. After a short rally higher, the stock dropped back a bit until the end of last week, but has picked up bullish momentum this week and appears to be forming a useful, bullish pullback pattern. Does the company’s fundamental strength and value proposition together make this a stock that is worth paying attention to? Let’s dive in and find out.

Fundamental and Value Profile

Avangrid, Inc. is a renewable energy and utility company. The Company operates through two segments: Networks and Renewables. The Networks segment includes all the energy transmission and distribution activities, and any other regulated activity originating in New York and Maine, and regulated electric distribution, electric transmission and gas distribution activities originating in Connecticut and Massachusetts. The Renewables segment owns, develops, constructs and operates electricity generation, including renewable and thermal generators, and associated transmission facilities. The Renewables segment includes activities relating to renewable energy, mainly wind energy generation and trading related with such activities. AGR’s current market cap is $13.4 billion.

Earnings and Sales Growth: As of January, earnings grew a little more than 7% in the prior twelve months, while revenues dropped -2.7%. In the most recent quarter, earnings grew 2.7% while revenues rose a little over 11%. AGR’s operating profile is healthy, with Net Income running at 11.5% of revenues in the trailing twelve-month period, and increasing to 13.42% in the last quarter. This is an indication that AGR’s margin profile is higher than normal its industry, which is a solid sign of strength compared to many of its industry brethren.

Free Cash Flow: AGR’s free cash flow is negative, at a little more than $-1.1 billion. This is a metric that has been declining since the beginning of 2019 and is a significant red flag.

Debt to Equity: AGR has a debt/equity ratio of .43, which is very conservative for this industry, but is also a little misleading. Their balance sheet shows just $26 million in cash and liquid assets versus about $6.7 billion in long-term debt. Liquidity is a legitimate concern despite their healthy operating margins; any kind of shortfall in their margins would almost immediately translate to a challenge in their ability to service their debt.

Dividend: AGR pays an annual dividend of $1.76 per share, which translates to a yield of 4.1% – well above the average for the S&P 500. 

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at about $46.50 per share. That means the stock is trading at a modest discount of about 8% below that fair value.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The diagonal red line on the chart above outlines the stock’s downward trend from its February peak around $57 to its March low at around $35.50. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. After rallying into the middle of April to about the 50% retracement line at around $46, the stock dropped back until earlier this week, finding a higher support from the March low at around $39. The stock has picked up bullish momentum from that point and is approaching immediate resistance at around $44 from the 38.2% retracement line. A reversal back down should see the stock fall to about $40, while a push above $44 should offer upside to at least $46, with next resistance around $49 from the 61.8% retracement line attainable if bullish momentum picks up.

Near-term Keys: Despite AGR’s attractive dividend and operating profile, I see enough red flags from their declining, negative Free Cash Flow and limited liquidity to pass on categorizing the stock as any kind of useful long-term opportunity right now – value, growth, or otherwise. There could be some interesting possibilities to work with short-term trades, however depending on the stock’s near-term price activity. Use a push above $44 as a signal to consider buying the stock or working with call options, using $46 to $49 for profit targets. A pivot off of resistance and back lower could be a useful signal to consider shorting the stock or working with put options, using $40 as a practical profit target on a bearish trade.

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