Is there any steam left in utilities?
In the first quarter, safe-haven utilities exhibited one of their best performances, gaining ~11%. The broader markets continued to sway over trade war tensions, but they rose more than 13% in the quarter.
Top regulated utility Southern Company (SO) was the top gainer among utility giants in the period, surging more than 17%. Duke Energy (DUK) and renewables titan NextEra Energy (NEE) rose 4% and 12%, respectively. Dominion Energy (D) soared 7% in the same period.
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Utility stocks and Treasury yields generally trade inversely. The ten-year Treasury yield recently closed at 2.47% and fell 8% during the quarter. While the inverted yields seem to have been overturned for now, broader market uncertainty could continue to bother investors, which could boost utilities.
NextEra Energy continued its stupendous earnings growth in 2018. It finished the year with a rise of 15% YoY (year-over-year) in its adjusted EPS. Duke Energy’s and Southern Company’s earnings marginally increased, while Dominion Energy’s adjusted EPS rose 13% YoY.
NextEra Energy, the biggest utility by market cap, is trading at 22x its forward earnings, which seems exorbitant. Peers Dominion Energy and Duke Energy are trading at 18x, well in line with the industry average. Southern Company’s valuation multiple is below 17x, the lowest among the top utilities.
These stocks’ valuations seem inflated when it comes to their earnings growth. Utilities are expected to increase their EPS 4%–6% annually for the next few years, which might not justify their current valuations. Even if we consider their premium dividend yields and dividend growth, these utility stocks (XLU) look to be trading at significant premiums. Safe-haven utilities’ relatively slow earnings growth and premium valuations could be an obstacle to their rally going forward.