| | | Re: Utilities - According to Morningstar
Utilities Valuation Runs Hot and Cold About Exposure to Inflation, Interest Rates, Clean Energy Travis Miller
travis.miller@morningstar.com
While the market frets over inflation, interest rates, and U.S. economic growth, utilities investors show no fear.
Utilities climbed 13% during the fourth quarter of 2021, beating the Morningstar US Market Index's 9% rise. At 4% overvalued and 19 median price/earnings, utilities once again sport valuations that seem to ignore any macroeconomic risks.
Inflation is particularly worrisome for utilities, given their mostly fixed revenue and high share of raw materials and labor costs. But if interest rates can hit a sweet spot that tames inflation without alienating income investors, utilities are well positioned to produce another year of 7%-9% total returns, given attractive dividend yields and infrastructure growth. Overall, we think investors should expect steady but underwhelming returns from utilities in 2022.
× Our top utilities picks NiSource, Edison International, and Entergy have lagged peers since 2020 but have robust clean energy growth, constructive rate regulation, and dividend yields well above 3%.
× Duke Energy, NextEra Energy, and WEC Energy Group trade near our fair value estimates but have growth and regulatory support that meet or beat peers with similar premium valuations.
× Utilities' 3.2% average dividend yield is historically high relative to the 1.8% 10-year Treasury yield. This gives income investors some headroom against inflation and rising interest rates.
× Clean energy is a long-term growth trend as utilities' customers and policy-makers try to bolster their green credentials. Utilities with regulatory support have long runways of 6%-8% annual growth
Utilities Can Handle Higher Interest Rates Utilities enter 2022 well prepared to withstand rising interest rates. There are four reasons we think rising interest rates won't hurt utilities as much as they have historically.
Utilities' Dividend Yields Are Still Attractive.
Utilities remain one of the few attractive options for income investors.
Utilities' 3.2% dividend yield remains historically attractive relative to interest rates, offering plenty of yield protection for investors even if interest rates rise.
Persistently low interest rates have allowed utilities access to cheap debt for growth investments and refinancing. We estimate this access to low-cost financing has created a 10%-15% equity valuation premium relative to a 4.5% long-term average risk-free rate.
Higher Rates Reduce Regulatory Risk Utilities will continue to benefit from a wide spread between interest rates and regulatory allowed returns on equity even if interest rates rise. This spread creates shareholder value by supporting earnings growth, high payout ratios, and strong balance sheets. |
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