Utility stocks have hit the skids, with the S&P 500 utilities index returning negative 19% year to date through Friday.
Indications that the Federal Reserve will keep interest rates “higher for longer” have weighed on the sector. Higher rates hurt utilities because they borrow heavily for their structures and equipment.
And higher interest rates make the dividends of utility stocks less competitive compared with bond yields.
“U.S. utilities now trade at a median 15% discount to our fair-value estimates,” wrote Morningstar utilities strategist Travis Miller. “This matches the largest discount since the market bottoms in March 2009 and March 2020. Utilities’ median price-earnings ratio of 16 is their lowest since exiting the 2008-09 recession.”
He offered his top three choices for utility stocks – “utilities that we think can grow earnings and dividends faster and for longer than their current market valuations imply.”
Here’s the terrific threesome.
Entergy
(ETR) -), which distributes electricity to Arkansas, Louisiana, Mississippi and Texas.
Morningstar moat (durable competitive advantage) rating: narrow. Morningstar fair-value estimate: $120. Friday price quote: $91.70. Forward dividend yield 4.47%.
“Entergy offers one of the most attractive combinations of yield, growth, and value in the utilities sector, with a 7% annual earnings growth outlook,” Miller said. Entergy’s price-to-earnings multiple of 14 represents a 15% discount to the sector average.
“Above-average electricity-demand growth, clean-energy investments, and reliability/resiliency network investments are core growth drivers” for the company, he said.
“Entergy also should benefit from industrial carbon-emissions cuts, global energy demand, and green-hydrogen development.”
NiSource
(NI) -), which distributes natural gas in in Indiana, Kentucky, Maryland, Ohio, Pennsylvania and Virginia.
Morningstar moat rating: narrow. Morningstar fair value estimate: $33. Friday price quote: $24.05. Forward dividend yield: 3.69%.
Though NiSource trades at a valuation similar to that of its peers, "we think it has one of the longest runways of growth in the sector,” Miller said.
“The firm’s transition from fossil fuels to clean energy in the Midwest supports at least a decade of growth potential. We expect NiSource to invest $15 billion over the next five years.” That should lead to about 7% annual earnings and dividend growth, he said.
Duke Energy
(DUK) -), which operates regulated utilities in the Carolinas, Indiana, Florida, Ohio and Kentucky
Morningstar moat rating: narrow. Morningstar fair value estimate: $105. Friday closing price: $86.92.
Forward dividend yield: 4.72%.
“After divesting its renewable energy business, Duke has a clear pathway to achieving management’s 5% to 7% annual earnings growth target,” Miller said.
“Duke’s $65 billion capital investment plan for 2023-27 is focused on clean energy and infrastructure upgrades to reduce carbon emissions.”
To be sure, while Duke’s yield is among the highest in the sector, dividend growth will lag earnings growth until its payout ratio comes down, Miller said. The payout ratio is dividend distributions divided by profit.
The author of this story owns shares of Duke Energy.
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