Utility equities outperform in March, trading at valuation premium over S&P 500

Introduction

The S&P 500 Utilities subsector outperformed the wider S&P 500 group for a fourth consecutive month in March; its rise of more than 10% month over month meant it was also in positive territory quarter over quarter. The S&P 500 gained 3.6% in March, after reaching a new low for 2022 on March 8, but was down 5.0% quarter over quarter. The Nasdaq Composite Index rose 3.4% month over month to pare its year-to-date decline to approximately 9%.

Given utilities' relative outperformance to close out the first quarter, the S&P 500 Utilities trade at a slight premium to the S&P 500 on a next-12-month stock price-to-estimated EPS basis as the broader markets remain volatile amid persistently rising inflation, the prospect of multiple interest rate hikes in 2022 and geopolitical concerns.

Data collected by S&P Global Market Intelligence suggests that some investors are wagering on a further downturn in U.S. equity markets, with short positions in all sectors of the stock market higher since mid-February. Utilities appear to be markedly less exposed to short interest activity, however, with approximately 2.2% of shares held short at mid-March, versus 5.2% of consumer discretionary, 4.1% of healthcare and 3.9% of energy stocks. For additional detail, see this article.

Looking ahead, Regulatory Research Associates, a group within S&P Global Commodity Insights, identified several developments and trends to watch in 2022 that may impact utility valuations, including inflation and rising interest rates, the treatment to be accorded stranded costs related to the energy transition, recovery of costs associated with severe weather events, the Russian invasion of Ukraine, the ongoing impacts of the COVID-19 pandemic and the upcoming midterm elections in the U.S.

Electric utility stocks outperformed other energy and water utility subsectors in March, led by Exelon Corp. (+11.9%) and Entergy Corp. (+11.0%). Forward valuations on a P/E basis for both companies climbed by a similar margin to 19.8x and 17.3x, respectively, owing primarily to share price appreciation in March rather than any meaningful revisions to consensus estimates for the companies' 2023 growth, according to data from S&P Global Market Intelligence. By comparison, average electric utility P/Es for 2023 stood at 19.0x at the end of March, having risen 8.5% on average.

In the absence of any apparent catalysts, share price appreciation in Exelon shares is possibly tied to investors' reentry into the stock following the spinoff of its competitive generation operations in early February and a reduction to the company's quarterly common stock dividend. Exelon shares declined more than 26% in February following its corporate restructuring.

At the other end of the spectrum within the electric utility subsector, the forward P/E multiples of Otter Tail Corp. and Hawaiian Electric Industries Inc. increased approximately 4% to 18.8x and 18.5x, respectively, as both of the stocks underperformed relative to other energy utility equities in March.

Following M&A-fueled share price appreciation in February driven by the proposed buyout of South Jersey Industries Inc., forward gas utility P/E multiples increased 5.4% on average in March, the smallest margin among energy and water utilities. Trading in the South Jersey Industries shares was relatively steady last month, while Northwest Natural Holding Co.'s forward P/E declined slightly, in tandem with a 0.6% decline in the company's stock price.

Atmos Energy Corp. outperformed for a fourth consecutive month in March to cement its position as a top-performing gas utility stock thus far in 2022. Its 2023 P/E multiple of 20.3x stands above the gas utility group average of 18.4x.

Multi-utility forward P/Es increased 8.2% on average in March, led by Sempra. The company is one of several U.S. LNG developers in recent months to describe strong interest among world gas buyers in U.S. projects amid soaring gas prices abroad and increased concerns over supply security following Russia's invasion of Ukraine. On March 31, Sempra and France's TotalEnergies SE announced a preliminary deal under which TotalEnergies may contract long-term for up to a third of the LNG produced by Sempra's proposed Vista Pacifico LNG project in Mexico. The preliminary deal was part of a broader agreement by the companies to develop new energy infrastructure.

The quadrant chart below shows how the RRA utility universe appears when comparing the P/E ratio and the estimated long-term earnings growth rate. A sizeable portion of utility P/E multiples remained largely in the upper-left quadrant throughout 2021 and into 2022, suggesting the companies could be relatively undervalued, considering their lower P/E values and long-term earnings growth potential.

Share price volatility

Smaller-cap companies generally have lower trading liquidity and, therefore, all other things being equal, tend to have more significant share-price swings than larger-cap equities. An analysis of the standard deviation of log-normalized daily price returns for utility stocks over the past year supports this thesis, with the generally smaller-cap gas and water utility sectors displaying the highest average price volatility.

Average electric utility share price volatility declined to 19.5% from 29.2%, driven by volatility declines in Exelon and PPL Corp. shares. Within the multi-utility sector, average price volatility declined to 19.5% from 23.5%, with notable declines observed among Duke Energy Corp., NorthWestern Corp. and Public Service Enterprise Group Inc.

Measured by the standard deviation from the average price, volatility quantifies how extreme are the price movements of a particular equity or group of equities. Utilities are generally considered to have lower volatility in share price compared with other industries. Trends towards lower overall volatility in utility segments, as highlighted above, may indicate a flight to safety by investors as they buy utilities and hold them for longer, especially such as in times of heightened geopolitical stress.

^{Regulatory Research Associates is a group within S&P Global Commodity Insights.}

^{S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.}

^{This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.}