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Utilities’ Outlook for 2016 Remains Stable

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Valuation

Historically, independent power producers in the US traded at an average EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) of 8.2x. Currently, they’re trading near 9x. These higher valuations can be explained by asset expansion. New business acquisition activities occurred in the sector to increase the exposure to regulated operations.

The above chart shows utilities’ performance in terms of their market movement and dividend payouts.

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Analysts are bullish

Despite the negative impact of the interest rate hike looming over utilities, Wall Street analysts forecast a stronger performance from them in the next year. According to analysts’ consensus estimates, Duke Energy (DUK) has maximum exposure to regulated operations. Analysts projected an upside of 12% in the coming one-year period. Duke Energy has a price target of $76. Southern Energy (SO) has a modest price target of $48. This accounts for an upside of ~7%.

On the other hand, NextEra Energy (NEE) showed consistent growth in dividend payouts. For NextEra Energy, the annual dividend growth in the last five-years stands at 9%. Exelon’s (EXC) dividend payouts fell by an average of 10% in the last five years.

Outlook for 2016

Moody’s expects electricity demand to remain subdued in 2016 due to energy efficient programs and milder weather. However, it reaffirmed a “stable” outlook for regulated utilities based on the sector’s financial performance, liquidity, and debt levels. The debt levels are forecasted to stay steady in 2016. Utilities’ (XLU) median debt ratio for their outstanding debt will likely stay around 55%.

A reduction of carbon usage in power generation and the improving operational efficiency in order to tackle the higher interest rates pose some serious challenges for utilities. Bottoming natural gas prices and renewables continue to offer cost competitiveness for power generation. It will be interesting to see utilities’ behavior with higher interest rates in 2016.

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