Rising interest rates can pose challenges for utility companies for two primary reasons: the burden of high debt levels and the potential shift in investor preferences.

Utilities play a critical role in providing essential services such as electricity, gas, and water to communities. Due to the significant capital investments required and the regulated nature of these businesses, utilities often face limited competition in their respective jurisdictions. However, rising interest rates pose challenges for utility companies because of debt and the potential shift in investor preferences.

Utilities provide key necessities such as electricity, gas and water. Given the large capital costs to establish these services and the regulated nature of the businesses, utilities typically face limited or no competition in most jurisdictions.

At the same time, though, the share prices of utility companies are generally hurt in a rising interest rate environment for two reasons: first, utilities overall carry high levels of debt and their interest costs will likely go up as rates rise; second, dividend investors may find rising yields on fixed-income instruments more appealing when compared to the dividend yields on utility companies.

However, the main attraction of utilities remains their secure and steady growth provided by long-term contracts with energy regulators. Meanwhile, when rates peak and then fall, the interest of investors in utilities companies and ETFs should rebound.

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Utilities hold high levels of debt

Large and ongoing expenditures to build and maintain utility infrastructure requires substantial capital. Steady revenue streams provided by those assets assure lenders that utilities will be able to service their debt consistently. All in all, this lets utilities hold considerable debt on their balance sheets.

The low-interest environment, which prevailed in Canada, the U.S., and many other parts of the world for several years, started to change in 2022. That continues and has had negative implications for highly leveraged companies, including utilities.

One note of caution: although the financial health of these utilities was in good standing at the end of 2022,  inflation and rising interest rates have forced up their interest payments and the cost of refinancing their debt.

Overall, though, given the steady income streams provided by many utilities, it is not surprising that these companies can consistently pay high and rising dividends.

The betas of the utility companies are also very low, which indicates that their share prices are considerably less volatile than the overall market.

Are rising interest rates impacting your investing decisions?