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How Fairly Are US Utilities Valued to Their Historical Averages?

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Valuation

US utilities started their rally in late 2015, and it lasted until 2Q16. During this timeframe, US utilities saw peak valuations. In 4Q16, they are trading at a comparatively fairer valuation to their five-year historical average.

US utilities have historically traded at an average EV-to-EBITDA[1. enterprise value to earnings before interest, tax, depreciation, and amortization] valuation of 10x–11x. During the rally on the slower-than-expected pace of interest rate hikes from the Federal Reserve in 2016, these valuations peaked at 13x–14x.

The EV-to-EBITDA ratio indicates whether a stock is undervalued or overvalued, regardless of capital structure. EV is the combination of a company’s debt and market capitalization minus its cash holdings.

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Valuing top utilities

Duke Energy’s (DUK) EV-to-EBITDA valuation multiple stands at 11x while Southern Company’s (SO) multiple is also at 11x. Renewable energy giant NextEra Energy (NEE) and Dominion Resources (D) have valuation multiples of ~11x and ~15x, respectively. Both companies have their five-year historical averages near their current multiples.

With respect to the price-to-earnings (or PE) multiple, US utilities have historically traded near 15x. During 2016, their PE multiples exceeded 20x. NextEra Energy is trading at a price-to-earnings multiple of 21x, whereas Duke Energy and Southern Company each have a PE multiple of 17.5x.

After 2Q16, utilities started their downward movement over the increased possibility of a rate hike by the Fed. Prospective higher interest rates could discourage utilities’ stock movements, but dividends are not expected to be hampered significantly due to the relatively stable earnings growth of utilities (XLU).

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