This Utilities Play Could See Some Spark This Year

The movement to cut global greenhouse gas emissions through the shift to electric cars and other vehicles will endure for decades, placing additional reliance on the grid, utility infrastructure, and renewable energy. Here, we'll examine a key mid-cap player in this trend, Itron (ITRI) , a $3.24 billion market cap name.

Utility stocks were battered in 2023, thanks to rising interest rates, questioning some of the necessary investments from increasing electricity demand. With interest rates declining in 2024, two investment themes are in focus for potential gains: mid-cap stocks and investments in sustainability and energy efficiency.

Itron serves utilities and municipalities with products to measure, analyze, and optimize electricity, gas, and water consumption. The stock landed on Cowen's top ideas for 2024 and is a play on these investment themes.

Itron, based in Washington State, is one of the largest providers of smart infrastructure technology. More than 8,000 customers in over 100 countries use its broad hardware and software services and products. Their applications for grid stability and smart city transformation are an integral part of the electrification of transportation. Last year, the company earned $2 billion in annual revenue selling smart meters with two-way communication to utilities along with grid optimizing software. The stock has traded sideways for 20 years, but the company has fully integrated a large acquisition in 2018 and rationalized its corporate expenses and businesses for durable growth with recurring revenues.

Public utilities have spent about $134 billion annually, according to Edison Electric Institute, as electricity usage has grown about .4% annually over the last 20 years. But projections for growth to approach 2% over the next decade support increased investments in grid growth and optimization, especially when electric generation comes from vastly more diverse and decentralized sources.

Some demand drivers for electricity include air conditioning use from hotter summers, heat pumps replacing boilers, the electrification of transportation, and data centers with vastly more energy-consuming chips.

Itron's "distributed energy resource management systems" business develops software to help utilities manage the diverse sources of electricity generation, including rooftop and solar farm production directed toward the grid. Cowen believes Itron's business has continued momentum in 2024, as it shows the value of this business segment. Their hardware backlog of $4.3 billion supports visibility, with solid "recession resilient" bookings. Although the stock was up 30% last year, Cowen, with a $95 target, thinks the margin improvement story is under-appreciated.

Itron trades at less than 2-times revenues with a forward price-to-earnings of 23. The company continues to improve efficiency through an asset-light model. Nearly 50% of production is outsourced vs. 2% in 2016, with fewer manufacturing sites. But supply chain challenges have offset much of the improved efficiency, which only recently has started to abate. SG&A expense has been reduced from 17.8% of revenues in 2018 to 14.5% in 2023, helping the bottom line.

Others on Wall Street have recently found cause for bullishness after their strong earnings report in November. Piper upgraded ITRI to a "buy" in December with a $91 target. The firm believes there's meaningful upside to earnings this year. Itron's leverage to utility spending provides high revenue visibility.

It's conceivable Itron could be an acquisition target for large industrial company that wants to compete with Eaton's (ETN) smart meter and grid optimization business -- such as Honeywell (HON) , which acquired Elster, a gas measuring and metering company, for $5 billion in 2016. But more likely Itron's deleveraging and improved cash flow will allow for smaller bolt-on merger.

On the other hand, Raymond James downgraded ITRI to "market perform" last week, with the stock nearing its $80 price target. Itron pulled forward some demand due to the loosening of chip supply, so they see difficult comps this year with no catalysts on the horizon other than possibly software M&A.

Some other uncertainties include the trajectory of interest rates, lumpiness in Itron's software business from one-time licensing fees, and the November presidential election, which can hamper climate change spending incentives under Republican control of the White House and Congress.

After a strong year for Itron, business momentum likely continues. Clear visibility with a burgeoning software business, emphasizing improving margins, should continue to benefit ITRI. Improving the grid for growth and stability is a priority for utility spending and a mega-trend on the long road to decarbonization, which helps make ITRI a long-term winner.

At the time of publication, Ginesin was long ITRI.