• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Investment Insights>Our Outlook for Utilities Stocks

Related Content

  1. Videos
  2. Articles
  1. Peters: Don’t Be Scared by Scotland

    The U . K . will remain a good hunting ground for dividend-paying stocks even if Scotland decides to become independent, says Morningstar's Josh Peters.

  2. Watch for Warning Signs When Chasing Dividend Yield

    Investors need to be aware of a stock's potential total return and avoid overpaying for a company that has an attractive headline yield, cautions Sanibel Captiva's Pat Dorsey.

  3. Challenges, Opportunities for Utilities Under Trump

    While rising interest rates may threaten utility valuations, we think gas and power prices will stay low and renewable energy growth will continue.

  4. Can You Rake In Higher Dividend Yields Abroad?

    Policy and valuation factors have contributed to higher dividend yields on overseas investments, but currency exposure and withholding taxes could take a bite out of your total return, says Morningstar's Josh Peters.

Our Outlook for Utilities Stocks

Final environmental regulations give utilities near-term certainty but no comfort.

Travis Miller, 12/29/2011

--Utilities have now announced coal plant closures totaling 30 GW of the 53 GW we project to comply with two landmark EPA air emissions rulings during the second half of 2011.

--Warmer-than-normal summer weather in 2010 and 2011 and still-tepid demand forecasts are setting up 2012 for tough earnings comps.

--Still-falling natural gas prices are offsetting forward heat rate expansion, keeping power prices flat despite the favorable supply-demand conditions projected in the coming years.

With the Environmental Protection Agency's mid-December publication of the final Air Toxics Rule, utilities in the eastern United States now know all of the environmental mandates they must meet in the next three to four years and can begin the compliance-planning process in earnest. We expect 2012-15 to represent landmark changes in the utilities sector along the lines of the Energy Policy Act of 2005 and deregulation in the 1990s. Even before the final Air Toxics Rule, utilities continued to announce plans to retire and retrofit their coal plants. We've now tallied 30 gigawatts of planned or executed coal plant retirements, representing 10% of the U.S. coal fleet, and we expect more to come.

We think the power markets slowly are beginning to reflect this tightening supply-demand balance up to 2015, offering wider margins for power producers with relatively clean fleets and entrenched positions in coal-heavy regions. These winners include Exelon EXC, Public Service Enterprise Group PEG, and NRG Energy NRG. Despite a 20% drop in average forward gas prices since June, forward power prices in key eastern U.S. regions have fallen just 10%, demonstrating the market's expectation for significantly tighter supply-demand conditions in the coming years. Yet forward heat rates in the coal-heavy mid-Atlantic region remain backward-dated, offering what we think is an opportunity for additional upside in power prices.

Although regulated utilities won't experience the same direct gross margin impact as their merchant peers, they could come under significant regulatory pressure as they petition for higher customer rates to recover increased power costs and new infrastructure investment to comply with the rules. Utilities have about $80 billion of annual investment planned for 2012 and 2013, most of it to address environmental regulations or renewable-energy targets. Key pending mergers involving Progress Energy PGN and Duke Energy DUK, and Northeast Utilities NU and Nstar NST relate directly to funding requirements for significant investment plans.

Industry-Level Insights
Shareholders of diversified utilities and independent power producers face the most exposure to environmental regulations and power market developments. Exelon's large nuclear fleet in the Midwest and mid-Atlantic regions give it a clear advantage and more upside to environmental regulations than any other U.S. utility. We calculate a 10% move in 2014 power prices results in about $0.50 per share of earnings and $5 per share of value. In November, Exelon raised its 2013 gross margin forecast for the second consecutive quarter to $6.2 billion, 10% higher than its low-end forecast at the beginning of the year.

Developments in Ohio during the fourth quarter could open up a fierce lion's den of competition among megaretailers during the next few years. American Electric Power AEP and Duke Energy both moved toward full deregulation by 2015. We expect a flood of high-powered retailers such as AEP, Duke, Constellation Energy CEG, and FirstEnergy FE to pursue those customers aggressively. Exelon's pending merger with Constellation gives Constellation even more firepower to attack that Midwest region. All have significant generation fleets in the region that can serve acquired retail load and capture premium margins relative to market rates. Retail businesses also help smooth diversified utilities' cyclical generation profits, which we expect will bottom in 2012 for most.

Travis Miller is an associate director for the utilities sector.

©2017 Morningstar Advisor. All right reserved.