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Stock Analyst Update

Buying Opportunity Amid Long-Awaited Utilities Sell-Off

The sector is 7% undervalued based on Morningstar's fair value estimates.

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Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

U.S. utilities' 15% sell-off March 11-12 leaves the sector cheaper than it's been since 2009. The sector is 7% undervalued based on Morningstar's fair value estimates.

We think this downturn opens long-awaited buying opportunities, especially for defensive investors. Most utilities are financially strong with attractive growth potential and historically high dividend yields relative to interest rates. We do not plan any significant fair value or moat rating changes based on coronavirus impacts.

Before the downturn, we were among the few who thought utilities valuations were far too rich. U.S. utilities peaked at 21% overvalued in mid-February based on our fair value estimates. The sector is down 24% since then.

Utilities' 3.3% average dividend yield is more attractive than it has been in at least 40 years relative to interest rates. Investors now get 260 basis points of yield premium to the 10-year U.S. Treasury rate, nearly matching the all-time high premium in mid-2012.

High-quality utilities like Duke Energy (DUK), Dominion Energy (D), and Southern Co. (S), offer investors dividend yields above 4% and trade at discounts to fair value. Top pick AES (AES) yields 4.7%, trades at a 45% discount to fair value, and is investing heavily in renewable energy growth.

Gas utilities have suffered recently due to concerns that gas restrictions in California might expand. CenterPoint Energy (CNP), New Jersey Resources (NJR), and DTE Energy (DTE) also have been hurt by falling midstream energy valuations. These are among the cheapest utilities based on our belief that U.S. gas demand will continue to grow and midstream assets are undervalued.

Power producers Vistra Energy (VST) and NRG Energy (NRG) have fallen from their late 2019 highs as power markets turned bearish, as we forecast. Vistra is most attractive, trading at a 34% discount to fair value and 30% cash flow yield. We expect both companies to return substantial cash to shareholders through dividends and stock buybacks during the next three years.

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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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