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Quarter-End Insights

Utilities: How Long Can the Yield Paradox Survive?

Utilities' dividend yields still look good, growth is on track, and balance sheets are strong, offering income investors hope that a potential sector collapse would be mild.

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  • Despite a brief sector swoon as interest rates rose during the third quarter, the Morningstar U.S. Utilities Index remains near record highs. Morningstar's worldwide utilities sector coverage traded at a 1.05 market-cap-weighted price/fair value as of the end of August, but the median price/fair value for the U.S. utilities we cover is 1.11. We still have no 4- or 5-star fully regulated utilities in our worldwide coverage.
  • The 190-basis-point spread between U.S. utilities' 3.6% average dividend yield and 1.7% 10-year U.S. Treasury yield suggests utilities could have a long way to run, based on historical averages. Even with historically high valuations, U.S. utilities' dividend yields and growth potential remain attractive for long-term income investors.
  • The key risk to our earnings growth outlook is a cut in regulated utilities' allowed customer rates. We estimate every 1 percentage point cut in rate-setting allowed returns on equity cuts our aggregate earnings growth outlook to 3% from 5%.
  • European utilities continue to search for ways to manage through regulatory, political, and economic challenges. If the market rewards newly slimmed-down E.ON and RWE's Innogy spin-off with the premium valuations of their regulated peers, shareholders could benefit.

 

Travis Miller does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.