The Reserve Bank of Australia (RBA) is gearing up to hike its benchmark interest rate next Tuesday. That would mark the central bank’s sixth consecutive rate increase as it attempts to tame inflation. The Utilities sector is among those most sensitive to interest rates changes.
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We’ll take a look at ASX utilities shares AGL Energy Limited (ASX:AGL) and Contact Energy Limited (ASX:CEN) to see how they are placed ahead of the RBA rate review.
How do rising interest rates affect utilities shares?
The S&P/ASX 200 Utilities (XUJ) index has dropped about 4% over the past week. The index has declined over 12% in the past month and has gained just over 8% over the past year.
Increasing interest rates can be a double-edged sword for utility providers. Utility companies are heavy borrowers, considering the capital-intensive nature of their business. As a result, rising interest rates can increase the borrowing cost for utilities, which could in turn weigh on their profit margins.
On the other hand, utility companies could see a relief in operating cost pressures if rising interest rates helps to solve the inflation problem. The RBA’s stated aim with the rate hikes is to bring inflation under control. If they work as intended, the rate increases could result in lower input prices for utility providers. That could in turn improve profit margins for the companies.
AGL Energy’s share price target signals nearly 30% upside potential
The Australian energy utility company generates and sells electricity to wholesale and retail customers. It also runs a natural gas wholesale and retail business. The company recently distributed a semi-annual dividend of AU$0.10 per share. AGL Energy stock currently offers a strong dividend yield of 9.2%, compared to the sector average of 2.7%.
Although AGL Energy shares have declined about 18% over the past three months, they are up about 8% year-to-date. According to TipRanks’ analyst rating consensus, AGL Energy stock is a Moderate Buy. The average AGL Energy price target of AU$8.70 implies nearly 30% upside potential.
Contact Energy share price forecast suggests over 40% upside
The New Zealand energy utility company runs electricity and gas wholesale and retail businesses. It also has a broadband business. Contact Energy shares have climbed about 9% in the past three months, but they are still down about 6% from where they were a year ago.
According to TipRanks’ analyst rating consensus, Contact Energy stock is a Moderate Buy. The average Contact Energy price forecast of AU$10.16 implies 44% upside potential.
Concluding remarks
Considering that rising rates could impact utility companies, investors need to choose their utility shares carefully. While the pool of utilities shares to select from is vast, AGL Energy and Contact Energy stocks stand out among analysts’ favourites amid increasing interest rates.
