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Quarter-End Insights

Utilities: Tough to Stop This Sector's Powerful Performance

Current spreads suggest utilities could still produce attractive returns even if the Fed continues to raise rates.

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  • On a global basis, utilities continue to be overvalued, with a 1.12 market-cap-weighted price/fair value ratio as of the end of May. On an equal-weighted basis, U.S. utilities' 1.15 P/FV and 21 forward P/E as of mid-June are down from their mid-2016 peak but still far above what we consider reasonable. We see more value among the large European diversified utilities, but we caution those come with higher uncertainty ratings and few 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. This continues to play out. In June, the 10-year U.S. Treasury rate fell again to 2.2%, yet utilities' dividend yields have held near 3.5%, with dividend growth offsetting still-climbing stock prices. The 130-basis-point spread between Treasuries and dividend yields remains a bullish signal.
  • Despite the Trump administration's recent decision to exit the Paris agreement, we continue to see strong renewable development opportunities for utilities. We continue to forecast U.S. renewable energy capacity doubling during the next eight years. State renewable portfolio standards, or RPS, and other local policies remain the industry's primary growth driver, not federal environmental policy.
  • Rising interest rates and a dearth of potential acquirers has quashed the regulated M&A market, but depressed independent power producer valuations have received interest from private equity firms that have the appetite to stomach near-term volatility for long-term upside.

 

Andrew Bischof 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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