The utilities sector encompasses all companies whose core business involves producing, generating, or distributing basic utilities: gas, electricity, and water. The average debt-to-equity ratio, or D/E ratio, for the utilities sector in the second quarter of 2022 was 0.12. In the fourth quarter of 2018, it reached .15, which was enough for Moody's Investors Service to issue and maintain a negative outlook on U.S. regulated utilities for 2019.
Key Takeaways:
- The average debt-to-equity ratio, or D/E ratio, for the utilities sector in the second quarter of 2022 was 0.12.
- Utilities typically carry high debt levels, and they are subject to interest rate risk.
- Utility sector stocks companies generally tend to perform best when interest rates fall or are low.
Understanding the Debt-To-Equity Ratio
The D/E ratio is a metric used to determine the degree of a company's financial leverage. Since utilities typically carry high debt levels, they are subject to interest rate risk, and the D/E ratio is a key metric for evaluating a company's overall financial health. The industries that typically have high D/E ratios are utilities andfinancial services, whereas wholesalers and service industries tend to have low D/E ratios.
Capital-intensive industries, such asoil and gasrefining or utilities, such as telecommunications, require significant financial resources and large amounts of money to produce goods or services.
The telecommunications industry invests heavily in infrastructure, for example, installing thousands of miles of cables to provide customers with service. There are also ongoing capital expenditures for necessary maintenance, upgrades, and expansion of service areas. All of these costs and financial commitments mean high levels of debt and interest expense, which raises the D/E ratio.
The stocks of utilities sector companies generally tend to perform best when interest rates fall or are low because they typically hold high levels of debt.
Calculating theD/E Ratio
To calculate a company's D/E ratio,you divide its total liabilities by the amount of equity provided by stockholders. This metric reveals the respective amounts of debt and equity a company uses to finance its operations. The D/E ratio for a sector can be determined by calculating and averaging the D/E ratios for all of the companies within the sector.
When a company’s D/E ratio is high, this is usually a sign that the company has taken an aggressive financing approach to debt. In this case, additional interest expenses can often cause volatility in earnings reports. If earnings generated are greater than the cost of interest, shareholders benefit. However, if the cost of debt financing outweighs the return generated by the additional capital, the financial load could be too heavy for the company to bear.
D/E Considerations for the Utilities Sector
Evaluating a company using the D/E ratio is dependent on the company's industry. Capital-intensive industries, such as utilities, have relatively higher D/E ratios. Therefore, D/E ratios should be considered in comparison to similar companies within the same industry. Generally, ratios of 0.5 and below are considered excellent, while ratios above 2.0 are viewed more unfavorably.
Utilities often carry high debt levels as their infrastructure requirements make large, periodic capital expenditures necessary. However, they also have a large amount of investment equity because they are such "bedrock" stocks; they are included in the investment portfolio of many funds and individual investors.
