The utility has outperformed, but staying in power is not a sure thing

The utility has outperformed, but staying in power is not a sure thing

Utilities stocks swept the market as a whole in 2022.

The S&P 500 utilities index is up 4% this year, compared to a 19% loss for the S&P 500 overall.

Utilities stocks benefited as investors look for stability and yield amid a volatile market. This allowed these stocks to overcome the negatives of high inflation and interest rates.

High inflation hurts utilities because regulators often do not allow them to raise their prices to match their rising costs. Higher rates hurt utilities because they make dividend yields less competitive with bond yields.

Moreover, higher interest rates raise utility borrowing costs. These companies often have to borrow a lot of money to finance their projects.

But the stability factor outweighed the negatives.

Additionally, investment opportunities in new clean energy will enable utility companies to expand over the next decade,

Morningstar chief equity analyst Travis Miller said in a comment. “There is better long-term growth in the industry now than ever before.”

Currently, …

Clean Energy Incentives

The federal government, through the Inflation Reduction Act, and state governments have created incentives for more investment in clean energy. Next year “looks like it’s going to be a very strong year for solar and wind growth,” Miller said.

All the enthusiasm for utilities stocks has made this sector the most overvalued market in the market, according to Morningstar analysts.

As of September 15, the utilities segment traded at an 8% premium over Morningstar analysts’ fair value estimates. Analysts cover 37 stocks.

Excel Energy (XEL) The CMS Power (CMS) It was the most exaggerated, at 26%. Only one stock of utilities has been undervalued – NiSource (NI) 9% off.

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“I’m not surprised they’ve gone up in prices, but I wouldn’t be surprised if their prices go up,” Rahil Siddiqui, senior research analyst at Neuberger Berman, told Morningstar.

“In times of economic downturn, it is common for utilities stocks to become more expensive as investors look to stabilize them.”

Many experts predict a recession later this year or next.

Historical returns

Utility stocks have generated a total annual return of 8.97% over the past 30 years, which is roughly the equivalent of 9.8% in the broader market, Morningstar noted.

But Miller noted that inflation was not as high during that period as it is now – over 8% – and rates were not rising as fast.

โ€œInterest rates and inflation are hitting utilities on a more fundamental basis than they are affecting other companies,โ€ Miller said.

โ€œIt is unusual for the past history that utilities were the second best performing sector when you have very high inflation and interest rates [rising]. “

He sees rising inflation as a “long-term risk to the sector”. This “indicates that we will see lower returns in the sector than we have seen in the past.”

So now may not be the time to expand the facilities.

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