US utilities appear to be gradually returning to a fair valuation in 2017. They traded at a hefty premium in 2016. On January 20, 2017, Dominion Resources (D) was trading at an EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiple of over 15x.
Dominion’s five-year historical average stands at 14x. Currently, the industry average is near 10.5x. Dominion appears to be trading at a fair valuation compared to its peers.
An EV-to-EBITDA ratio gives a comparative idea of a company’s valuation, regardless of its capital structure. EV is the combination of a company’s market capitalization and debt minus its cash holdings.
NextEra Energy (NEE) is one of the largest utilities by market capitalization. It was trading at an EV-to-EBITDA multiple of 12x. Duke Energy’s (DUK) EV-to-EBITDA was 10x, while Southern Company’s (SO) EV-to-EBITDA was near 12x.
US utilities (XLU) have traded at a five-year historical average PE (price-to-earnings multiple) of 15x–16x. On January 20, 2017, the average was near 18x, a fair premium to the historical average. Dominion was trading at a PE of over 23x. Duke Energy and Southern Company were both trading at PEs of 19x.
Lately, US utilities have been moving in response to the Federal Reserve’s commentary. Interest rates can impact utilities due to their large capital expenditure needs. Interest rates can also directly impact utilities stocks as they become less attractive compared to bonds. The Fed’s tone will remain an important cue for utilities going forward.