PGIM Jennison Funds Q2 2024 Commentary: Utility and Natural Resources Sectors in Focus

PGIM Jennison Utility Fund Q2 2024 Commentary

In absolute terms, utilities were the largest contributor to performance, with electric utilities, the IPPs & renewables segment, and multi-utilities accounting for most of the absolute return. The sector advanced again this quarter, outperforming the broader market. The lack of Fed rate cuts has been a headwind to the sector after initially benefitting from the end of Fed tightening in late 2023. A handful of independent power producers (IPPs) and utilities with the ability to grow generation have been the biggest beneficiaries. Continued investor enthusiasm for the strong outlook for generative artificial intelligence-related data center power demand growth propelled shares of our utilities sector and energy midstream holdings higher during 2Q24 due to rising expectations for forward power prices, regulated utilities electricity load growth, renewable energy development activity, and natural gas demand for gas-fired generation. We believe strong long-term fundamentals and still-reasonable valuations underscore the opportunity in the utilities sector. Utilities gained 4.7% in 2Q24, slightly ahead of the 4.3% return of the S&P 500. Within the S&P 500 Utilities Index, IPPs and renewables were the strongest performers, followed by water utilities and electric utilities. Multi-utilities also advanced this quarter, while gas utilities were down during the quarter. The PGIM Jennison Utility Fund advanced and outperformed the 4.7% return of the S&P 500 Utilities Index over the second quarter. In absolute terms, utilities were the largest contributor to performance, with electric utilities, the IPPs & renewables segment, and multi-utilities accounting for most of the absolute return. Exposure to out-of-index sector midstream energy was a modest contributor to performance. Relative to the index, the overall contribution from utilities was the largest contributor this quarter to performance. IPPs were the highest contributors within the utilities sector to relative performance due to a relative overweight and stock selection. Multi-utilities also contributed positively to relative performance, primarily due to stock selection. A relative underweight in electric utilities detracted modestly from performance. This was offset by a small relative underweight in gas utilities this quarter. An out-of-index exposure to midstream energy was another positive relative contributor. Out-of-index exposures to data center real estate investment trusts (REITs) and renewable equipment providers detracted from relative performance. NextEra Energy is the largest utility in the U.S. and is one of the pre-eminent developers of renewable energy in the country. After a period of sub-par performance last year, the company benefitted from a combination of moderating interest rates, a favorable conclusion to a complaint regarding Florida political contributions, and a renewed focus on NextEra's competitive advantage in the expanding renewable development outlook. We increased our position and continue to favor NextEra as we believe the company should be able to deliver at the high-end of its earnings per share growth range long-term while benefitting from increasing U.S. power needs related to AI datacenters. Vistra Corp. is an IPP operating an integrated retail and electric power generation business primarily in markets throughout the U.S. IPPs such as Vistra have performed very well this year given the market's belief that data center-driven demand growth due to generative AI will drive up power prices. Constellation Energy Corporation produces carbon-free energy and distributes nuclear, hydro, wind, and solar energy solutions. IPPs such as Constellation have performed very well this year given the market's belief that data center-driven demand growth due to generative AI will drive up power prices. Constellation also benefitted from its status as the only pure-play nuclear operator offering both clean and reliable power. Nextracker is an energy solutions company that provides solar tracker and software solutions for utility-scale and distributed generation solar projects in the United States and internationally. While NEXTracker's Q1 results continued a trend of strong operational and financial performance, we exited our position during the quarter due to concerns regarding increasing competitive intensity and in favor of higher conviction power generation holdings. NRG Energy together with its subsidiaries, operates as an energy and home services company in the United States and Canada. It operates through Texas; East; West/Services/Other; Vivint Smart Home; and Corporate Activities segments. We initiated a position in NRG this quarter due to our positive view on power prices and earnings before interest, taxes, depreciation, and amortization (EBITDA) upside related to data-center power demand growth. However, the stock along with other IPPs declined late in the quarter on profit taking and on regulatory/supply response concerns in Texas. We continue to see favorable risk/reward for NRG given its leverage to the data-center power demand outlook. Exelon Corporation is a utility services holding company. It operates six transmission & distribution only utilities serving six states (IL, MD, PA, DE, D.C., NJ). Exelon's shares fell during the quarter due to continued regulatory concerns in Illinois from its re-application for grid modernization spending and cost recovery, as well as a disappointing rate case outcome in Maryland. We remain underweight Exelon but see potential for a positive re-rating later this year on a benign IL regulatory outcome. Continued investor enthusiasm for the strong outlook for generative AI-related data center power demand growth propelled shares of our utilities sector and energy midstream holdings higher during 2Q24 due to rising expectations for forward power prices, regulated utilities electricity load growth, renewable energy development activity, and natural gas demand for gas-fired generation. Additionally, our holdings in European utilities enjoyed a rebound during the quarter as forward power prices bounced sharply off their March lows thereby providing investors with a more gradual scenario for the anticipated normalization of profitability from utilities' power generation assets. We believe strong long-term fundamentals and still-reasonable valuations underscore the opportunity in the utilities sector. Additionally, we continue to believe that sustainability factors appear to be more influential in determining investment outcomes over time. Utility fundamentals are healthy, and we believe our regulated electric utility, independent power generator, and renewable energy developer holdings are well-positioned to capitalize upon a projected upward inflection in electricity demand growth driven by rapidly rising data center power needs, continued electric vehicle adoption, and further electrification of a broad array of industries. The global quest for CO2 emissions reductions is driving increasing demand for renewable energy and electric vehicles -- the subsequent grid infrastructure investment needed to modernize aging networks and facilitate this evolution of electricity supply and demand should drive growth in the sector for the foreseeable future. From an overall positioning standpoint, we favor utilities with above-average projected earnings and/or dividend growth, solid and sustainable dividend yields, and that operate in constructive regulatory environments that support timely and attractive returns on capital deployed. We continue to seek out companies that can mitigate customer bill impacts by focusing on operating efficiencies, versus the common strategy of serial rate increase requests. In our view, 'energy transition' investment is supported by two broad and enduring themes: (1) pronounced reductions in the cost of renewable energy, driven by continued technological advancement, and (2) increasing public policy support driven by concerns over greenhouse gas emissions, energy security, and most recently, job creation. The many decarbonization-related financial incentives included in 2022's Inflation Reduction Act have made the U.S. the most attractive market for renewable energy development in the world, in our opinion, and will likely accelerate energy transition within the U.S. Our midstream energy exposure contributed positively to Fund returns in 2Q24 as underlying fundamentals for our holdings remain strong, free cash flow improves, and capital return to shareholders continues to increase. Our energy infrastructure exposure is focused on midstream companies with assets we believe should be chief beneficiaries of a strong outlook for domestic demand for natural gas and global demand for U.S.-sourced liquefied natural gas (LNG), as well as management teams that place a priority on prudently returning excess free cash flow to shareholders. In our view, midstream companies with strong balance sheets, integrated asset systems with multiple touchpoints across the energy value chain, free cash flow generation, and strong environmental, social, and governance (ESG) metrics will continue to fare well going forward.

PGIM Jennison Natural Resources Fund Q2 2024 Commentary

Several of the Fund's holdings in renewables-related companies were also weak for the period. For most natural resources markets, the second quarter marked some areas of strength but also some weakness on the back of first quarter's broad gains. Copper prices stood out on the upside with a continued surge through much of the quarter, squeezing to a record level by mid-May. Although the copper price pulled back significantly at the end of the period, copper producers still ended leading performance for the quarter, and we think appropriately so given what's a strong fundamental backdrop. Gold stocks also performed positively after prices surged in April and then held for the rest of the quarter. Oil prices fell much of the quarter, again off the March peak, only to rise later in June but the oil equities, perhaps reflecting demand and the Organization of the Petroleum Exporting Countries (OPEC) spare-capacity concerns, did not rebound. Natural gas prices bounced off a depressed winter bottom, but the stocks followed only in a mixed and partial way, which in our view reflects constrained supply that could cap further price strength. The PGIM Jennison Natural Resources Fund advanced and outperformed its Lipper Global Natural Resources Index benchmark for the quarter. In absolute terms, the Fund saw strong performance from many of its metals & mining holdings -- including both industrial metals and precious metals companies. The Fund's energy holdings had mixed results with some having nice gains, but others -- especially energy equipment & services stocks -- declined for the quarter. Several of the Fund's holdings in renewables-related companies were also weak for the period. Hudbay Minerals (HBM) is a mid-cap copper mining company with existing producing assets in Peru and Canada and a large-scale greenfield project in Arizona. The updated 3-year production guide at the end of the first quarter, which contained no major surprises, served as a clearing event of any concerns of a downgrade to the outlook. The sentiment among many copper producers, including Hudbay Minerals, was favorable during the quarter as BHP pursued mergers and acquisitions (M&A) to bolster its copper portfolio and as copper prices rose from $4/lb to over $5/lb between the start of April through mid-May. The company particularly benefitted as the anticipation of higher future cash flows served to accelerate the company's debt reduction ambitions which serve as a catalyst to begin work on its greenfield project. We see several opportunities for the company to continue to meet and exceed expectations as it advances several small projects to improve productivity in the coming quarters. Cameco (CCJ) explores, develops, mines, refines, converts, and fabricates uranium. The company offers uranium for sale as fuel to nuclear power reactors worldwide. There is a growing appreciation for nuclear energy's zero carbon, extremely reliable characteristics to be part of the solution when it comes to the lowering of emissions in concert with growing world economies. With Cameco participating in all parts of the nuclear energy fuel cycle, it is benefitting from recent trends in the nuclear energy space, namely existing plants extending their useful life, the restart of several previously idled plants as well as emerging economies building new plants. As a result, we've seen a steady advancement in uranium pricing and nuclear fuel services with Cameco being able to negotiate ever higher prices on contracts out to the end of the decade. Shell PLC (SHEL) operates as an energy and petrochemical company in Europe, Asia, Oceania, Africa, the United States, and the rest of the Americas. The company operates through Integrated Gas, Upstream, Marketing, Chemicals and Products, and Renewables and Energy Solutions segments. The new management team at Shell continues to execute on the 2-year plan it laid out last year of improving cost structure and performing a strategic review on several troubled assets. Shell delivered a solid first quarter result that was highlighted by 1) an integrated gas business that delivered despite weak liquefied natural gas (LNG) prices, 2) the sale of its money losing Singapore chemical park, 3) an operational improvement at its Pennsylvania chemical park, and 4) a continuation of a robust buyback program. We continue to see more opportunity for this strategy as despite solid stock performance over the last year, valuations remains attractive, and cash returns significant. Vallourec SA is a multinational manufacturing company headquartered in France. Vallourec specializes in hot rolled seamless steel tubes, expandable tubular technology, automotive parts, and stainless steel, which it provides to energy, construction, automotive, and mechanical industries. We initiated a position in the first quarter of 2024. While the company's turnaround to improve margins and de-lever the balance sheet continues to make strides, weakness in steel/OCTG (its primary product) weighed on shares during the quarter. In addition, while having very little revenue exposure to the country, political uncertainty in France weighed on shares similar to other Paris listed equities. We think Vallourec's international exposure will be differentiated and execution on the strategy should yield benefits in the coming quarters. ConocoPhillips is a global independent exploration and production (E&P) company that explores for, produces, transports, and markets crude oil, bitumen, natural gas, LNG, and natural gas liquids (NGLs). The company has operations in the U.S., Latin America, Canada, Europe, Asia Pacific, and the Middle East. While ConocoPhillips continues to execute consistently, the decline in oil prices during the quarter likely led to some concerns on its ability to continue to return cash to shareholders as it has several long-term capital-intensive projects. A longer than expected turnaround at one of their assets likely heightened that concern. Toward the end of the quarter, the company announced a deal to buy Marathon Oil. We think the deal makes strategic sense but probably was a bit of a surprise to the market. Halliburton is a global provider of services and products to the upstream oil and natural gas industry. While it is a global provider, given its dominant position in North America, the share price often serves as a proxy for U.S. land activity. After holding steady for the first 3 months of the year, the U.S. land rig count fell 6.5% during the second quarter which is likely going to dampen the earnings and cash flow growth the Street currently expects for the back half of the year. We think Halliburton is in a good position to benefit from the consolidation in the E&P space and differentiated solutions should provide some insulation to the downtick in activity. While copper supply tightness seemed understood and reflected in rising March prices, further clarity around data center growth plans from artificial intelligence hyperscalers shifted the narrative from supply to demand as data centers, particularly around generative AI, require massive amounts of reliable, and if possible clean, electricity. Hyperscaler's ambitions call on copper throughout the power chain, from generation to distribution and transmission as power load not only grows materially for the first time in decades but will also need to be modernized to accommodate the intermittent (solar + wind) sources that end-customer-emissions targets necessitate. Our large and stable copper position size reflects our confidence level on the durability of this base-metals sector. While oil's outlook faces the dual headwinds of demand concerns and an excessive amount of OPEC spare capacity, there have been bright spots found among international oil services providers. International spending, particularly offshore, should continue to grow not only this year but for the next several years following discoveries over the past few years. Such earnings visibility has supported some of these international pure plays in the Fund. In contrast, a view that Saudi Arabia and the UAE will sooner rather than later have to ease their production constraint, suppressing prices, has afflicted E&P companies and U.S. land oilfield services providers as activity from those E&P customers slows in a compounded way as those E&Ps do more with less. We have largely held our integrated and E&P positions as we don't share the market's demand concerns nor the view that additional OPEC supply is imminent. Despite nuclear being a thin sector in our public-equity universe, it's worth mentioning standout performance from one of our largest holdings, Cameco, a now-integrated uranium-to-nuclear- equipment provider. In some ways similar to copper, uranium strength centers on supply pressures from Russian geopolitics but more so on demand as nuclear's clean, reliable power will be increasingly called upon globally. The renewables sector continues to wallow amid high interest rates and uncertain government incentives and although our holdings are minimal in this area, First Solar has been a standout performer.