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Utilities: Valuations Still Running Out of Control

Even the outlook for tightening monetary policies worldwide can't stop utilities from reaching near-record valuations.

Travis Miller
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  • On a global basis, utilities are approaching valuation peaks last seen in mid-2016. The sector has a 1.08 market-cap-weighted price/fair value ratio as of Aug. 31. On an equal-weighted basis, U.S. utilities' 1.15 P/FV and 21 forward P/E are only slightly off 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.
  • Despite the elevated valuations, low market interest rates make utilities' dividend yields look relatively attractive for income investors. The 10-year U.S. Treasury rate continues to hold near 2.2%, and utilities' dividend growth is holding their average yield at 3.5% despite the sector's rally. The 130-basis-point spread between Treasuries and dividend yields remains a bullish signal.
  • Renewable energy growth remains a long-term opportunity for utilities struggling with weak customer usage growth. Electricity demand has been mostly flat since 2011. We think demand growth will climb to 1.25% in the long run, but it could be several years before that happens. State renewable portfolio standards and other local policies remain the primary growth driver for renewable energy, not federal environmental policy.
  • Utilities M&A remains active and likely will continue as long as interest rates stay low.  WGL Holdings (WGL),  Great Plains Energy (GXP),  Westar Energy (WR),  Sempra Energy (SRE), and  Calpine (CPN) are all involved in proposed deals. In Europe, deal-making rumors continue to swirl. Calpine was the latest independent power producer to fall into private equity hands when Energy Capital Partners and others offered a 51% premium. This boosted values for peers  Dynegy (DYN) and  NRG Energy (NRG), but we don't see either of them as private equity targets.

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