- On a global basis, utilities now trade mostly in line with our fair value estimates at a 1.0 price/fair value ratio, the same as last quarter. In the U.S., utilities are slightly overvalued as a group, but most of the high-quality firms trade at 15%-20% premiums to fair value.
- Most utilities across our coverage continue investing heavily in infrastructure, ranging from renewable energy to local energy distribution. As long as energy prices remain stable, we expect 5%-7% annual earnings and dividend growth across the sector during the next few years.
- U.S. utilities' 3.45% sector dividend yield is just 40 basis points higher than the 10-year U.S. Treasury yield after the recent falloff in bond prices. This is among the smallest premiums since bond yields fell below the utilities dividend yield in 2008. We think the valuation tailwind that utilities have enjoyed from this yield premium could be easing.
- M&A has slowed in 2018 after its blistering pace in 2015-17. The worldwide pool of midsize utilities that would be good targets is shrinking. Most utilities have enough internal investment opportunities to sustain earnings growth without M&A. Reshuffling continues among some large European utilities, most notably recent speculation that giant Electricite de France (EDF) could split up.
- Hurricane Florence, California wildfires, and the Boston-area gas pipeline explosion in the U.S. illustrate the unplanned operational risks that can hurt utilities investors' returns.
Utilities appear to have hit a valuation plateau, but we still think downside risks outweigh upside catalysts. After reaching peak valuations in November 2017, U.S. utilities have underperformed the S&P 500 by 17 percentage points. Since the sector reached our fair value midyear, performance stalled. But regulated U.S. utilities still trade at 19 price/earnings, 13% higher than their 10-year average.
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Travis Miller does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.