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Quarter-End Insights

Utilities: Is There Enough Growth to Offset Higher Interest Rates?

Utilities stocks keep rewarding investors with attractive yields and growth, dispelling the long-held notion that rising interest rates will hurt sector returns.

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  • On a global basis, utilities continue to be overvalued, with a 1.07 market-cap-weighted price/fair value ratio as of mid-March. U.S. utilities have a 1.13 equal-weighted median P/FV, down from their peak 1.21 P/FV in mid-2016. We see more value among the large European diversified utilities, but those come with higher uncertainty ratings and weaker economic moats.
  • We've long told investors that a wide spread between utilities' dividend yields and interest rates would dampen the market's reaction to rising rates. That has played out. Even as 10-year U.S. Treasury rates have climbed to 2.6% in early March, utilities' average dividend yields fell to 3.5% now.
  • We think large-cap U.S. utilities offer the most value right now given their combination of growth, yield, and quality. Utilities like  Dominion Resources (D),  Duke Energy (DUK),  Southern Company (SO), and  American Electric Power (AEP) trade at a discount to their peers based on our valuations and their combinations of yield and growth.
  • Rising interest rates and a dearth of potential acquirers has quashed the M&A market, which could pressure the premium valuations that many small- and midsize regulated utilities have enjoyed for several years.

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

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