Buy This Undervalued Stock With a 4% Dividend Yield Before It’s Too Late

Entergy ETR offers one of the most attractive combinations of yield, growth, and value in the utilities sector, with a dividend yield above 4% and the potential for 7% annual earnings growth. Above-average electricity demand growth, clean energy investments, and reliability/resiliency network investments will drive growth. We expect the valuation discount on this dividend stock to disappear as the market becomes comfortable with the company’s decadelong business transformation away from commodity-sensitive businesses. Entergy makes our analysts’ list of their favorite 33 undervalued stocks for the first quarter. It is also among Morningstar chief U.S. market strategist Dave Sekera’s five cheap value stocks that look like bargains—for now.

Entergy’s growing, energy-hungry customer base and constructive rate regulation in the Southeastern United States give the company a long runway of earnings and dividend growth potential. We expect Entergy to invest more than $6 billion annually for the next five years to upgrade its large grid network and expand its clean energy portfolio. Industrial customers, which represent about half of Entergy’s customer base, generally support these investments as they aim to reduce carbon emissions. In the last few years, Entergy has transformed itself into a mostly regulated utility, similar to many of its peers. It no longer has direct energy market exposure. Given the growth potential of Entergy’s utilities, we expect dividend increases to track earnings growth.

Key Morningstar Metrics for Entergy

• Fair Value Estimate: $120
• Star Rating: 4 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: Low

Economic Moat Rating

Entergy has a narrow economic moat after retiring or selling all of its no-moat merchant nuclear power plants. A constructive regulatory environment for Entergy’s five regulated integrated utilities is the foundation of its moat. The utilities own difficult-to-replicate networks of power generation and distribution assets that provide essential electricity service to customers. Service territory monopolies and efficient scale advantages are the primary moat sources for regulated utilities. State and federal regulators grant Energy’s utilities exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their distribution networks. Within this regulatory framework, the threat of material long-term value destruction is low, and normalized returns should exceed Entergy’s cost of capital.

Read more about Entergy’s moat rating.

Fair Value Estimate for Entergy Stock

We expect energy use in Entergy’s service territories to grow faster than most U.S. utilities’ primarily due to industrial customer growth on the Gulf Coast. This growth and the region’s increasing demand for renewable energy support our outlook for more than $6 billion of annual capital investment during the next four years. Entergy’s capital investment opportunities combined with constructive regulation in most of its service territories support our forecast for 7% average annual earnings per share growth through 2027. We use a 5.8% cost of capital in our discounted cash flow valuation, which incorporates a 7.5% cost of equity. Our cost of equity is lower than the 9% rate of return we expect investors will demand of a diversified equity portfolio. A 2.25% long-term inflation outlook underpins our capital cost assumptions.

Read more about Entergy’s fair value estimate.

Risk and Uncertainty

An adverse regulatory decision would negatively affect Entergy’s earnings and cash flow. Unfavorable decisions are more likely in a period of rising electricity rates and inflation, so we expect more regulatory pushback in the near term. Weather is a significant uncertainty for Entergy’s regulated utility earnings and cash flow. A Gulf Coast hurricane or severe ice storm can cause billions of dollars of damage and reduce customer load for years. Entergy’s utilities would have to spend unbudgeted capital to restore service and might not recover all of those costs through higher customer rates in a reasonable amount of time.

Read more about Entergy’s risk and uncertainty.

Entergy Bulls Say

• Industrial electricity rates that are well below the U.S. average are driving strong industrial development in the Mississippi Delta and electricity sales growth.
• In November 2023, the board raised the dividend 6% for the third consecutive year. We expect dividend growth to continue at a similar rate for the foreseeable future.
• We believe the decision to exit the merchant nuclear business demonstrates good capital allocation as those earnings had high variability.

Entergy Bears Say

• Gulf Coast storms are always a risk, especially in Louisiana. These could result in large unplanned operating and capital costs that Entergy might not be able to recover from customers.
• Entergy’s large capital investment plan for new generation has construction execution risk.
• Rising interest rates and inflation can slow earnings growth and make utilities like Entergy a less attractive income investment.

This article was compiled by Susan Dziubinski and Sylvia Hauser.