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With More Utilities Going Bankrupt in Texas, Are Utility Stocks Really Safe?

Earlier this month, Brazos Electric Power Cooperative filed for bankruptcy protection following the impact of recent severe winter storms in Texas. What made this filing notable was that Brazos is the largest and oldest power cooperative in the state. It went from a "financially robust, stable" company before the storms to stressing under the weight of $2.1 billion of bills owed to the state's grid operator following the devastating weather event.

It's the second notable utility bankruptcy in recent years. California-based PG&E (NYSE: PCG) filed for bankruptcy protection following a series of devastating wildfires that hit the state. Extreme weather was the culprit in both cases. It therefore seems as if utility stocks might not be as safe as investors think.

Image source: Getty Images.

Lower risk doesn't mean risk-free

PG&E looked like a safe stock before it declared bankruptcy in 2019. It was one of the country's largest natural gas and electric utilities, supplying energy to more than 16 million people across Northern and Central California. As a government-regulated monopoly, it generated relatively steady revenue. It also seemingly had a solid financial profile. Major credit rating agencies gave it their stamp of approval by rating its credit investment-grade, implying that it had the financial resources to meet its obligations even if market conditions deteriorated.

However, an economic downturn is one thing. A multibillion-dollar liability for wildfires is too much for even the strongest of utilities to handle without the bankruptcy court system's assistance.

Texas' utilities are facing a similarly daunting problem. They had the financial wherewithal to handle most storms, both economic and natural, but there are limits. Brazos reached its breaking point following the recent winter storms, which knocked most of the state's power grid offline. The price of available electricity skyrocketed from an average of $20.79 per megawatt-hour (MWh) in the weeks before the storm to as much as $9,000 per MWh at its peak. That proved to be a crushing blow for the company.

Image source: Getty Images.

Keeping risk in mind

As PG&E and Brazos demonstrate, even financially stable utilities can encounter catastrophic financial situations. Investors should therefore still treat utilities with caution, even those with rock-solid financial profiles, because even that might not be enough to weather a catastrophic climate event. That means considering a utility's risk potential and not overallocating too much of one's portfolio to any utility.

As an example, let's take a closer look at the risk profile of top-tier utility NextEra Energy (NYSE: NEE). The global renewable energy leader boasts having one of the top financial profiles in the utility sector. It generates predictable cash flow backed by government-regulated rates and long-term fixed-rate contracts. The utility also has a lower-than-average dividend payout ratio and A-rated credit, backed by solid leverage metrics.

However, NextEra operates electric utilities in hurricane-prone Florida. While it has invested heavily in storm-hardening its infrastructure, there's a risk that a series of devastating hurricanes could slam into Florida in one season. That could cause catastrophic damage to its operations or customer base, which might put significant pressure on its share price or affect its ability to pay a growing dividend. That hopefully won't ever occur, but it's a potential risk that investors need to keep in mind. Given that possibility, investors in NextEra, or any other utility stock, should take a hard look at their allocation and consider dialing it back if it's too high for their risk tolerance.

Safer doesn't mean riskless

Because utilities generate reasonably predictable revenue backed by government-regulated rates, they're less risky then other companies. However, while they're generally safer, they're not without risk, which is clear from the sector's recent bankruptcies caused by extreme weather events. With climate change concerns on the rise, investors need to keep this in mind when investing in utility stocks, since safer doesn't mean a completely safe investment.

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