Utilities Sector Outlook: Playing Offense or Defense?

Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Thematic (Sector/Industry)

United states Utilities / Thematic (Sector/Industry)

<p>Utilities continue to find ways to grow, employing $1.1 trillion in capital spending over the past decade, and we see a long runway for additional capital spend over our forecast. Edison Electric Institute, the electric industry's trade association, forecasts $223.9 billion in capital expenditures the next two years. But EEI has a history of being conservative with its estimates, and we think this remains true with its current forecast. We forecast industry capital expenditures of $279.2 billion.</p><p>Capital growth drives earnings and dividend growth. We forecast median 6.4% earnings growth and 5.5% dividend growth from 2019-22. However, investors have caught on to U.S. utilities' long-term growth prospects, driving valuations to a median 12% premium to our fair value estimates. If interest rates stay low and utilities' valuations stay rich, long-term investors could realize 10%-14% total returns from a combination of current dividend yields (3%-5%) and our earnings growth outlook (7%-9%) based on the sector's infrastructure needs. But should market valuations converge to our fair value estimates as we expect, investors would see flat returns.</p><hr><h2>Key Takeaways</h2><ul>
<li>Capital Expenditure Forecast: We forecast utilities we cover will spend nearly $449 billion over the next four years, fueling a healthy median 6.4% earnings growth and 5.5% dividend growth.</li>
<li>Transmission and Distribution Winners: Transmission and distribution investments represent nearly 65% of our projected total utility investments. These investments facilitate the continued transition from coal generation to natural gas and renewable energy. We highlight <a href="https://www.smartkarma.com/entities/1796" target="_blank" data-smartkarma-citation="entities:1796:1">Sempra Energy (SRE US)</a> and <a href="https://www.smartkarma.com/entities/16455" target="_blank" data-smartkarma-citation="entities:16455:1">Edison International (EIX US)</a> for their electric transmission and distribution investment potential. <a href="https://www.smartkarma.com/entities/13170" target="_blank" data-smartkarma-citation="entities:13170:1">Atmos Energy (ATO US)</a> tops peers with gas distribution investments.</li>
<li>Renewable Energy Winners: We project renewable energy, excluding hydro, will grow 70% to 659 terawatt-hours from 2017 to 2025 and represent almost 15% of the U.S. generation, up from 9.6% in 2017. <a href="https://www.smartkarma.com/entities/7402" target="_blank" data-smartkarma-citation="entities:7402:1">Nextera Energy (NEE US)</a> and <a href="https://www.smartkarma.com/entities/26503" target="_blank" data-smartkarma-citation="entities:26503:1">Avangrid Inc (AGR US)</a> are particularly well positioned to capture this opportunity.</li>
</ul>

Utilities continue to find ways to grow, employing $1.1 trillion in capital spending over the past decade, and we see a long runway for additional capital spend over our forecast. Edison Electric Institute, the electric industry's trade association, forecasts $223.9 billion in capital expenditures the next two years. But EEI has a history of being conservative with its estimates, and we think this remains true with its current forecast. We forecast industry capital expenditures of $279.2 billion.Capital growth drives earnings and dividend growth. We forecast median 6.4% earnings growth and 5.5% dividend growth from 2019-22. However, investors have caught on to U.S. utilities' long-term growth prospects, driving valuations to a median 12% premium to our fair value estimates. If interest rates stay low and utilities' valuations stay rich, long-term investors could realize 10%-14% total returns from a combination of current dividend yields (3%-5%) and our earnings growth outlook (7%-9%) based on the sector's infrastructure needs. But should market valuations converge to our fair value estimates as we expect, investors would see flat returns.Key Takeaways
Capital Expenditure Forecast: We forecast utilities we cover will spend nearly $449 billion over the next four years, fueling a healthy median 6.4% earnings growth and 5.5% dividend growth.
Transmission and Distribution Winners: Transmission and distribution investments represent nearly 65% of our projected total utility investments. These investments facilitate the continued transition from coal generation to natural gas and renewable energy. We highlight Sempra Energy (SRE US) and Edison International (EIX US) for their electric transmission and distribution investment potential. Atmos Energy (ATO US) tops peers with gas distribution investments.
Renewable Energy Winners: We project renewable energy, excluding hydro, will grow 70% to 659 terawatt-hours from 2017 to 2025 and represent almost 15% of the U.S. generation, up from 9.6% in 2017. Nextera Energy (NEE US) and Avangrid Inc (AGR US) are particularly well positioned to capture this opportunity.


Capital Investment Drives Utilities' Growth, but Valuations Are Rich