Utilities are among the safest investment bets given the regulated nature of their business that gives their revenues a high level of certainty. They also benefit from the domestic orientation of their business, which shields them from foreign currency translation issues that have been a headwind for many other industries lately.

Though demand for utility services like electricity, gas and water varies with the swings of the economy, the fortunes of these companies don’t vary to the same extent as the economic cycle. After all, these companies providing basic services can never go out of business -- this is their most basic fundamental strength. Their ability to boost shareholders’ value through consistent dividends makes them all the more attractive.

To provide an uninterrupted supply of basic amenities, utilities need to upgrade and strengthen their infrastructure and modernize the generation fleet. These modifications enable utilities to meet increasing demand and abide by stringent environmental regulations laid out by state and federal agencies.

The Environmental Challenge

Utilities have heavily relied on coal for a large part of power generation, which has become a big challenge for the group in these times of enhanced environmental awareness. Curbing pollution is now an ongoing process and the regulators have fixed standards of emission that need to be achieved within a stipulated timeframe. Utilities are installing smart meters, attaching scrubbers to lower emissions and launching energy efficiency programs to reduce customers’ energy consumption.

Governments across the world are enforcing ever stricter rules and mandates to bring down the industry’s carbon footprint. In Aug 2015, the U.S. Environmental Protection Agency released the final version of the Clean Power Plan. The plan calls for CO2 reduction of 28% by 2025 and 32% by 2030, from 2005 levels.

Infrastructure investments need a huge amount of money, which makes the sector very capital intensive. Utilities generate funds from operations which help them to some extent to meet their capital requirements. However, they mostly have to resort to external sources of financing to carry out their generation, distribution and transmission projects.

Something to Cheer About

Utilities have hitherto benefited from rock bottom interest rates. In addition, the ongoing improvement in the U.S. economy has led to more jobs and higher housing unit completion, which in turn is driving utility demand. The sector is expected to continue enjoying near-zero rates for some more time as the Federal Reserve kept rates unchanged citing weakness in the global economy as the primary reason.

Per the U.S. Bureau of Labor Statistics, the unemployment rate in August was down by 1 percentage point year over year to 5.1%. New home sales increased 5.7% year over year, thanks to steady job gains and low mortgage rates while the overall average hourly earnings of employees improved on a year-over-year basis.

Recent projections from the U.S. Energy Information Administration (EIA) indicates that electricity use will increase by 2.1% in the residential space in the second half of 2015. The EIA forecasts electricity demand in the commercial sector to grow by 0.7% in 2015 while industrial sector electricity sales are expected to fall by 0.2%. The EIA further projects commercial and industrial sales in 2016 to increase by 1.3% and 1.2% respectively. New jobs and robust housing demand will definitely benefit utility operators.

Zacks Industry Rank - Neutral

Within the Zacks Industry classification, utilities are a standalone sector, one of 16 Zacks sectors. The rural wire-line telephone companies are also grouped within the Zacks Utility sector, but the three major industries within this sector include Electric Power, Gas Distribution and Water Supply.

We rank all of the 258 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank.

The way to look at the complete list of Zacks Industry Rank for the 258+ industries is that the outlook for industries with Zacks Industry Rank of #88 and lower is 'Positive,’ between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.’

After scanning the utility sector, we find that all the three prominent industries fall under the first two categories. Water Supply has a Zacks Industry Rank #50, Electric Power has a Zacks Industry Rank #96 and Gas Distribution has a Zacks Industry Rank #105.

Although our present outlook on this industry is Neutral, it has the potential to do better than current levels.

Earnings Results and Expectations

We are on the verge of completing the third quarter with the majority of utility earnings releases scheduled for the last week of October. Let’s recapitulate how this sector performed last season.

Year-over-year earnings growth from the utility sector in the second quarter of 2015 was 4.8%, in stark contrast with the S&P 500 decline of 2.1%. Earnings in the third quarter are however expected to contract at a clip of 4.6%, still better than the S&P 500 contraction of 5.9%. For the Q3 earnings season, total earnings for the sector are expected to be down -4.6% from the same period last year on 2.5% higher revenues.

Investors can consider adding the following utilities to their portfolio. They’ve been performing well on a consistent basis.

Edison International (EIX), a Zacks Rank #2 (Buy) stock, has a long-term earnings growth projection of 4.7% and a dividend yield of 2.7%.  Edison International has registered positive earnings surprises in the last four quarters with an average beat of 23.7%.

Atmos Energy Corporation (ATO), a Zacks Rank #2 (Buy) stock, has a long-term earnings growth projection of 7.0% and a dividend yield of 2.7%.  Atmos Energy has registered positive earnings surprises in the last four quarters with an average beat of 11.2%.

Consolidated Edison, Inc. (ED), a Zacks Rank #2 (Buy) stock, has a long-term earnings growth projection of 2.7% and a dividend yield of 3.9%.  Consolidated Edison has registered positive earnings surprises in the last four quarters with an average beat of 7.9%.

WGL Holdings Inc. (WGL) holds a Zacks Rank #2 and has an unblemished record of earnings beats in the last four quarters with an average of 121.8%. The stock has a long-term earnings growth projection of 6.0% and a dividend yield of 3.3%.

For more information about earnings for this sector and others, please read our 'Earnings Trends’ report.