Risky business: a closer look at TSR in the US power and utilities sector
2013 was a turbulent and transformative time for US investor-owned power and utilities companies. Speculation surrounding the Federal Reserve’s activist policies, including the much-anticipated tapering of its aggressive bond-buying program, impacted the utilities and the broader economy.
The broader equity markets were robust as the S&P 500 produced a total shareholder return (TSR) of 32.4%, shattering all-time highs along the way. But the utilities missed out on the party: the top 50 US utilities (EY50) registered a TSR of only 14.3%, marking the second year in a row the utilities underperformed the broader market.
Early into 2014, this trend has shown signs of reversing.
Through June 10, the EY50 has returned an impressive TSR of 12.9% compared with the S&P 500’s moderate TSR of 6.5%. Concerns regarding the situation in Russia/Ukraine and stalled growth in China have stymied the S&P 500 thus far, causing investors to focus their attention on safer investments, such as utilities.
However current valuation indicators for utility equities are unsettling. In 2014, the EY50 has enjoyed record-high P/E valuations, even amid a host of industry challenges and modest growth outlook.
This delicate balance is likely unsustainable, and any disruption could have severe implications on the equity performance. Our key findings:
- Utilities pop, then fizzle. Propelled by record-low Treasury rates, the largest 50 US utilities by market capitalization (EY50) surged past the broader market through May 2013, topping out at 20.1% TSR to the S&P 500’s 12.7%. However, utilities fumbled the rest of the year, finally settling at 14.3% TSR.
- We’re not out of it yet. EY50’s P/E valuations remained high (22.4x), but valuations were no longer supported by yields that were attractive relative to other investment options. If economic growth continues, utilities have further to drop.
- Industry challenges continue to mount. Utilities continue to feel pressure amid low energy commodity prices, stagnant demand, significant investment requirements and environmental mandates. Increasingly stronger regulatory regimes and competition from upstart distributed generation ventures create additional headaches.
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