Have US Utilities Become Overvalued?
So far in 2017, US utilities (XLU) seem to be fairly valued compared to their towering valuations in 2016. However, when compared to their five-year historical averages, utility stocks appear to be trading at a premium.
The EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) ratio indicates whether a stock is undervalued or overvalued regardless of its capital structure. Specifically, EV represents the combination of a company’s debt and market capitalization, minus its cash holdings.
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The heavy hitters
NextEra Energy (NEE), one of the largest utilities by market capitalization, is trading at an EV-to-EBITDA valuation multiple near 12x. The industry average valuation stands near 10.5x, while NextEra’s five-year average EV-to-EBITDA ratio is at 11x.
Southern Company (SO) also appears to be trading at a premium, with an EV-to-EBITDA ratio near 12x. Its five-year historical average is ~near 11x.
Among other US utility giants, Duke Energy (DUK) stock appears to be trading at a fair valuation as compared to peers, with a valuation multiple near 10x. DUK’s five-year average EV-to-EBITDA ratio is 11x.
As compared to large-cap regulated utilities, competitive utilities Exelon (EXC) and FirstEnergy (FE) seem to be trading at fair valuations as well, most likely due to their volatile stock price movements.
US utilities (XLU) seem to be trading at a marginal premium from the perspective of PE (price-to-earnings) multiple, however. Historically, they have traded at an average PE multiple of about 15x–16x. They are currently trading at PE ratio of above 19x.
In the next part, we’ll discuss why higher interest rates are negative for utilities.