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Quarter-End Insights

Utilities Power Past Fair Value

Some of the most defensive companies in the utilities sector have performed the best this year and could face a sharp drop if interest rates start to creep up.

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  • Utilities' market-beating run this year leaves the sector 7% overvalued as of mid-June. In particular, the higher-yielding, most defensive utilities have benefited from another pullback in interest rates.
  • In early June, the U.S. Environmental Protection Agency released the highly anticipated proposal for U.S. limits on carbon dioxide emissions from power plants. The proposal would reduce carbon emissions 30% from 2005 levels by 2030, but each state has its own targets, so not all utilities face the same risks. 
  • The Eastern U.S. and Texas should see significantly more volatile power prices this summer as more expensive natural gas plants continue to replace aging coal plants. Increased volatility and higher prices should strengthen the moats of low-cost, incumbent power producers.
  • The utilities sector average dividend yield remains near 4%, nearly double the market's average yield and 130 basis points above the 10-year U.S. Treasury yield.

 

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