Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Thematic (Sector/Industry)

<div class="content-highlight"><h2>Growth is hip, but valuations are a drag.</h2></div><hr><h2>Utilities Fundamentally Attractive, but Valuations Still Rich</h2><p>Halfway through 2019, utilities continue to impress with good growth prospects, secure dividends, and sound balance sheets. That's good for investors, who could realize 5%-7% annual dividend and earnings growth from many high-quality utilities with narrow moats and 3% yields.</p><p>But those strong fundamentals come at a high price. U.S. utilities in our coverage universe trade at a 14% premium to our fair value estimates on a median basis as of mid-June. That means investors' long-term capital gains are at risk even if utilities make good on their earnings and dividend growth potential.</p><p>Utilities' rich valuations also lessen their attractiveness as defensive investments in a market downturn. During the last two major U.S. bear markets—2007-09 and 2000-02—utilities' valuations going into the downturn had a big impact on the sector's outperformance relative to the market.</p><p>Investors should be selective as they pick utilities in this market, focusing on those with the best growth plans or cheap relative valuations to offset a valuation pullback we think is coming.</p><hr><h2>Key Takeaways</h2><ul>
<li>Utilities' long-term growth opportunities are abundant based on our discussions with utilities executives at the recent American Gas Association Financial Forum. We think renewable energy and distribution growth projects are the most attractive. Our May 20 report, <a href="https://www.smartkarma.com/insights/capital-investment-drives-utilities-growth-but-valuations-are-rich" target="_blank" data-smartkarma-citation="insights:29917">Capital Investment Drives Utilities' Growth, but Valuations Are Rich</a>, has more detail on utilities' growth plans.</li>
<li>Utilities are 14% overvalued as of mid-June based on our fair value estimates, the richest they have been since 2017. Regulated utilities are particularly expensive with median 22 P/E and 2.1 P/B—both multi-decade highs.</li>
<li>Utilities with large, attractive investment plans include <a href="https://www.smartkarma.com/entities/nextera-energy-inc" target="_blank" data-smartkarma-citation="entities:7402:1">Nextera Energy (NEE US)</a>, <a href="https://www.smartkarma.com/entities/edison-international" target="_blank" data-smartkarma-citation="entities:16455:1">Edison International (EIX US)</a>, <a href="https://www.smartkarma.com/entities/dominion-energy-inc" target="_blank" data-smartkarma-citation="entities:5937:1">Dominion Energy Inc (D US)</a>, <a href="https://www.smartkarma.com/entities/xcel-energy-inc" target="_blank" data-smartkarma-citation="entities:6402:1">Xcel Energy Inc (XEL US)</a>, <a href="https://www.smartkarma.com/entities/new-jersey-resources-corp" target="_blank" data-smartkarma-citation="entities:19030:1">New Jersey Resources (NJR US)</a>, <a href="https://www.smartkarma.com/entities/cms-energy-corp" target="_blank" data-smartkarma-citation="entities:3143:1">Cms Energy Corp (CMS US)</a>, <a href="https://www.smartkarma.com/entities/sempra-energy" target="_blank" data-smartkarma-citation="entities:1796:1">Sempra Energy (SRE US)</a>, and <a href="https://www.smartkarma.com/entities/atmos-energy-corp" target="_blank" data-smartkarma-citation="entities:13170:1">Atmos Energy (ATO US)</a>. Although many of these are expensive, their growth should cushion returns if valuations compress.</li>
<li>Utilities' rich valuations limit their defensiveness. Utilities entered the 2007-09 bear market with a 19 P/E and outperformed the S&amp;P 500 by 11 percentage points, their worst bear-market performance in 35 years. Bear-market returns improved when utilities had more modest valuations.</li>
<li>Although utilities look rich on absolute valuation measures, the sector's 3.4% average dividend yield remains attractive relative to the 2.1% 10-year U.S. Treasury yield. Historically, utilities have outperformed bonds when their dividend yields are this much higher than interest rates.</li>
</ul><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/090/378/original/1.JPG?1560737544" class="editor-image img-responsive" data-smartkarma-image-id="90378"></figure>

Growth is hip, but valuations are a drag.Utilities Fundamentally Attractive, but Valuations Still RichHalfway through 2019, utilities continue to impress with good growth prospects, secure dividends, and sound balance sheets. That's good for investors, who could realize 5%-7% annual dividend and earnings growth from many high-quality utilities with narrow moats and 3% yields.But those strong fundamentals come at a high price. U.S. utilities in our coverage universe trade at a 14% premium to our fair value estimates on a median basis as of mid-June. That means investors' long-term capital gains are at risk even if utilities make good on their earnings and dividend growth potential.Utilities' rich valuations also lessen their attractiveness as defensive investments in a market downturn. During the last two major U.S. bear markets—2007-09 and 2000-02—utilities' valuations going into the downturn had a big impact on the sector's outperformance relative to the market.Investors should be selective as they pick utilities in this market, focusing on those with the best growth plans or cheap relative valuations to offset a valuation pullback we think is coming.Key Takeaways
Utilities' long-term growth opportunities are abundant based on our discussions with utilities executives at the recent American Gas Association Financial Forum. We think renewable energy and distribution growth projects are the most attractive. Our May 20 report, Capital Investment Drives Utilities' Growth, but Valuations Are Rich, has more detail on utilities' growth plans.
Utilities are 14% overvalued as of mid-June based on our fair value estimates, the richest they have been since 2017. Regulated utilities are particularly expensive with median 22 P/E and 2.1 P/B—both multi-decade highs.
Utilities with large, attractive investment plans include Nextera Energy (NEE US), Edison International (EIX US), Dominion Energy Inc (D US), Xcel Energy Inc (XEL US), New Jersey Resources (NJR US), Cms Energy Corp (CMS US), Sempra Energy (SRE US), and Atmos Energy (ATO US). Although many of these are expensive, their growth should cushion returns if valuations compress.
Utilities' rich valuations limit their defensiveness. Utilities entered the 2007-09 bear market with a 19 P/E and outperformed the S&amp;P 500 by 11 percentage points, their worst bear-market performance in 35 years. Bear-market returns improved when utilities had more modest valuations.
Although utilities look rich on absolute valuation measures, the sector's 3.4% average dividend yield remains attractive relative to the 2.1% 10-year U.S. Treasury yield. Historically, utilities have outperformed bonds when their dividend yields are this much higher than interest rates.


Utilities Sector Outlook: Playing Offense or Defense?

Materials Analyst/Strategist, Janus Analysis

Gaius King

Materials Analyst/Strategist

Accelerating Tomorrow’s Independent Research

Boost Research

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<ul>
<li>Quantifying nuclear statistics with substantial discrepancies</li>
<li>LT contracts &amp; speculative hoarding driving recent 40% spot price increase</li>
<li>Primary/secondary Uranium supplies currently 112% of 2017 demand</li>
<li>Uranium supply deficits extremely unlikely before 2022</li>
<li>Global Uranium demand to fall 25-40% by 2050</li>
<li> Primary Uranium sector LT SELL</li>
</ul>
<p>We have independently audited global nuclear construction statistics in order to determine future Uranium demand.  Although near-term statistics match those in the public domain, long-term demand determined via construction pipeline illustrates substantial discrepancies.  Compiling planned plant construction, operational extensions, nameplate upgrades, versus decommissioning announcements/events, and in many cases, public policy inertia; has led us to believe that despite historical primary supply shortages, global nuclear demand peaked in 2006.</p>
<p>Since plateauing and despite strong Chinese growth, nuclear power generation has fallen &lt;2% over the past two decades, a decline that is predicted to accelerate as a number of developed and developing nations pursue other energy options.</p>
<p>The macro-trend not replacing existing nuclear infrastructure means (dependent on assumptions), according to our calculations, global uranium demand will decrease between 20 to 40% by 2050.</p>
<p>As opposed to signifying a fundamental change in underlying demand, we believe that recent Uranium price increases are the result of producers closing primary operations, and substituting production with purchases on the spot market to meet long-term contract obligations.  In addition, hedge funds are buying physical uranium in order to realise profits on potential future commodity price increases.  Critically, we determine that primary and secondary supplies are more than sufficient to meet forecast demand over the next four to five years; before taking into account substantial existing global uranium stocks, some of which are able to re-enter the spot market at short notice.</p>


Quantifying nuclear statistics with substantial discrepancies
LT contracts &amp; speculative hoarding driving recent 40% spot price increase
Primary/secondary Uranium supplies currently 112% of 2017 demand
Uranium supply deficits extremely unlikely before 2022
Global Uranium demand to fall 25-40% by 2050
 Primary Uranium sector LT SELL

We have independently audited global nuclear construction statistics in order to determine future Uranium demand.  Although near-term statistics match those in the public domain, long-term demand determined via construction pipeline illustrates substantial discrepancies.  Compiling planned plant construction, operational extensions, nameplate upgrades, versus decommissioning announcements/events, and in many cases, public policy inertia; has led us to believe that despite historical primary supply shortages, global nuclear demand peaked in 2006.
Since plateauing and despite strong Chinese growth, nuclear power generation has fallen &lt;2% over the past two decades, a decline that is predicted to accelerate as a number of developed and developing nations pursue other energy options.
The macro-trend not replacing existing nuclear infrastructure means (dependent on assumptions), according to our calculations, global uranium demand will decrease between 20 to 40% by 2050.
As opposed to signifying a fundamental change in underlying demand, we believe that recent Uranium price increases are the result of producers closing primary operations, and substituting production with purchases on the spot market to meet long-term contract obligations.  In addition, hedge funds are buying physical uranium in order to realise profits on potential future commodity price increases.  Critically, we determine that primary and secondary supplies are more than sufficient to meet forecast demand over the next four to five years; before taking into account substantial existing global uranium stocks, some of which are able to re-enter the spot market at short notice.

Uranium - About to Enter Its Own Nuclear Winter

<p>The Best Ideas list is a compilation of stock ideas sourced from Morningstar’s global equity research team. With more than 100 analysts covering nearly 1,500 companies, we’re able to provide a wide variety of what we believe are attractively priced securities looking across sectors, industries, and geographies. Best Ideas are nominated by analysts and approved by managers in addition to the normal due diligence processes that precede our published research and ratings.</p><p>The list may include a broad mix of quality and risk characteristics to meet varying investor needs, including no-, narrow-, and wide-moat companies as well as the full spectrum of uncertainty ratings from low to very high. Most or all of the highlighted stocks will be trading at a discount to our estimate of intrinsic value, indicating improved odds of capital appreciation.</p>

The Best Ideas list is a compilation of stock ideas sourced from Morningstar’s global equity research team. With more than 100 analysts covering nearly 1,500 companies, we’re able to provide a wide variety of what we believe are attractively priced securities looking across sectors, industries, and geographies. Best Ideas are nominated by analysts and approved by managers in addition to the normal due diligence processes that precede our published research and ratings.The list may include a broad mix of quality and risk characteristics to meet varying investor needs, including no-, narrow-, and wide-moat companies as well as the full spectrum of uncertainty ratings from low to very high. Most or all of the highlighted stocks will be trading at a discount to our estimate of intrinsic value, indicating improved odds of capital appreciation.

Founder & CEO. Oil markets macro-analysis., Vanda Insights

Vandana Hari

Founder & CEO. Oil markets macro-analysis.

Vanda Insights

Vanda Insights is a Singapore-based boutique provider of intelligence on the global energy markets, launched in September 2016. The venture was born out of a desire to extract the signal from the noise in the complex and often volatile oil markets. Our succinct and clear macro analysis is relied upon by thousands of readers globally, including those doing business directly or indirectly in the physical commodity and derivatives markets; wealth managers; governments, regulatory bodies and think-tanks; as well as trade organizations and educational institutions.

Global Energy Markets

Commodities

<p>Two big bearish influences have yanked Brent and WTI down by $5-6/barrel from their 42-month peaks, but they may be overturned by a supply shock as we approach the fourth quarter of this year.</p>
<p>The first big slump was triggered in the second week of July by a substantial boost in Saudi production reported for June, which reversed 18 months of strict restraints by the kingdom under the OPEC/non-OPEC output reduction pact. Last week, crude took another knock from reports of a rising tide of supply…</p>

Two big bearish influences have yanked Brent and WTI down by $5-6/barrel from their 42-month peaks, but they may be overturned by a supply shock as we approach the fourth quarter of this year.
The first big slump was triggered in the second week of July by a substantial boost in Saudi production reported for June, which reversed 18 months of strict restraints by the kingdom under the OPEC/non-OPEC output reduction pact. Last week, crude took another knock from reports of a rising tide of supply…

Weekly Oil Views: Rising Supply and Trade Wars Weigh on Crude but Lull May Not Last

Asymmetric Payoffs, Thracian Capital Management

Asymmetric Payoffs

Thracian Capital Management

Macroeconomics

<p>Our sixty-page market commentary for the month of June, including macro analysis and trade ideas across asset classes-- macro, volatility, equities, foreign exchange, commodities and credit / interest rates. </p>

Our sixty-page market commentary for the month of June, including macro analysis and trade ideas across asset classes-- macro, volatility, equities, foreign exchange, commodities and credit / interest rates. 

United States

Sempra Energy is an energy services holding company with operations throughout the United States, Mexico, and other countries in South America.  The Company, through its subsidiaries, generates electricity, delivers natural gas, operates natural gas pipelines and storage facilities, and operates a wind power generation project.

Consolidated Edison, Inc., through its subsidiaries, provides a variety of energy related products and services. The Company supplies electric service in New York, parts of New Jersey, and Pennsylvania as well as supplies electricity to wholesale customers.

Public Service Enterprise Group Incorporated is a public utility holding company. The Company, through its subsidiaries, generates, transmits, and distributes electricity and produces natural gas in the Northeastern and Mid Atlantic United States.

Public Service Enterprise Group Inc (PEG US)

DTE Energy Company, a diversified energy company, develops and manages energy-related businesses and services nationwide.  The Company, through its subsidiaries, generates, purchases, transmits, distributes, and sells electric energy in southeastern Michigan. DTE is also involved in gas pipelines and storage, unconventional gas exploration, development, and production.

CMS Energy Corporation is an energy company operating primarily in Michigan. The Company, through its subsidiaries provides electricity and/or natural gas to its customers in Michigan. CMS Energy also invests in and operates non-utility power generation plants in the United States and abroad.

Ameren Corporation is a public utility holding company.  The Company, through its subsidiaries, generates electricity, delivers electricity and distributes natural gas to customers in Missouri and Illinois.

CenterPoint Energy, Inc. is a public utility holding company. The Company, through its subsidiaries, conducts activities in electricity transmission and distribution, natural gas distribution and sales, interstate pipeline and gathering operations, and power generation.

WEC Energy Group, Inc. operates as a utilities provider. The Company distributes electricity and natural gas to its customers in Wisconsin, Illinois, Michigan and Minnesota.

NiSource Inc. is an energy holding company. The Company's subsidiaries provide natural gas, electricity and other products and services to customers located within a corridor that runs from the Gulf Coast through the Midwest to New England.

MDU Resources Group, Inc. provides various commercial services. The Company offers distribution of electricity, natural gas, and construction materials, as well as construction services. MDU Resources Group serves customers in the United States.

Engie offers a full range of electricity, gas and associated energy and environment services throughout the world. The Company produces, trades, transports, stores and distributes natural gas, and offers energy management and climatic and thermal engineering services.

E.ON is one of Europe's largest operators of energy networks and energy infrastructure and a provider of innovative customer solutions for some 51 million customers. The company's operations are energy networks and customer solutions.

Engie SA offers a full range of electricity, gas and associated energy and environment services throughout the world. The Company produces, trades, transports, stores, and distributes natural gas, and offers energy management and climatic and thermal engineering services.

Veolia Environnement SA operates utility and public transportation businesses. The Company supplies drinking water, provides waste management services, manages and maintains heating and air conditioning systems, and operates rail and road passenger transportation systems.

National Grid plc is an investor-owned utility company which is focused on the transmission and distribution of electricity and gas. The Company owns and operates the electricity transmission network in England and Wales, the gas transmission network in Great Britain, and electricity transmission networks in the Northeastern United States and Scotland.

Centrica PLC is an integrated energy company offering a wide range of home and business energy solutions. The Company sources, generates, processes, stores, trades, saves and supplies energy and provides a range of related services.

YTL Power International Berhad is an investment holding company which provides administrative and technical support services. Through its subsidiaries, the Company develops, constructs, maintains, and operates power stations which includes Paka Power Station in Terengganu and Pasir Gudang Power Station in Johor.

YTL Corporation Berhad is an investment holding and management company. Through its subsidiaries, the Company operates an integrated infrastructure development which includes construction work on contractual basis, property development, power generation, and hotel development and management. YTL Corporation also manufactures industrial products and supplies.

A2A S.p.A. is an Italian utility company.  The Company is active in electricity (production, distribution, trading and sales), gas (supply, distribution, trading and sales), district heating, waste (collection, treatment and disposal), integrated water cycle, public lighting and other activities. A2A S.p.A  has a strong presence in the North of Italy.

Dominion Energy, Inc. produces and transports energy products. The Company offers natural gas and electric energy transmission, gathering, and storage solutions. Dominion Energy serves customers in the United States.

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Dominion Energy Inc (D US)

Utilities Sector Outlook: Playing Offense or Defense?

Growth is hip, but valuations are a drag.Utilities Fundamentally Attractive, but Valuations Still RichHalfway through 2019, utilities continue to...

Morningstar, Inc.

Uranium - About to Enter Its Own Nuclear Winter

Quantifying nuclear statistics with substantial discrepancies LT contracts & speculative hoarding driving recent 40% spot...

Boost Research

Best Ideas List for January 2019

The Best Ideas list is a compilation of stock ideas sourced from Morningstar’s global equity research team. With more than 100 analysts covering...

Morningstar, Inc.

Weekly Oil Views: Rising Supply and Trade Wars Weigh on Crude but Lull May Not Last

Two big bearish influences have yanked Brent and WTI down by $5-6/barrel from their 42-month peaks, but they may be overturned by a supply shock as...

Vandana Hari

Market Commentary (June 2016)

Our sixty-page market commentary for the month of June, including macro analysis and trade ideas across asset classes-- macro, volatility,...

Asymmetric Payoffs

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