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Utility valuations improve as EPS outlooks show resistance to COVID-19

Valuations on a stock price-to-earnings, or P/E, basis between the S&P 500 and S&P 500 Utilities contracted in July with the latter index among the top-performing sectors as measured by total return during the month. The indexes again separated somewhat into mid-August, with the S&P 500 resuming an upward trajectory and the utilities declining slightly. Since our July valuation analysis, the S&P 500's next-12-months P/E declined approximately 6% through mid-August versus the S&P 500 Utilities' approximate 3% increase.

For those companies with the largest 2021 P/E increases observed between July 10 and Aug. 14, share price appreciation appears to be the primary driver of the increases as most utilities' quarterly results did not reflect significant pandemic-related impacts but rather strong year-over-year growth, with most management teams affirming existing earnings guidance ranges. Among energy utilities, the multi-utility sector posted the highest average year-over-year earnings expansion for the second quarter, at 14.9%, while the gas and electric sectors saw average earnings growth of 13.1% and 8.5%, respectively.

Recent declines in the S&P 500's forward valuation could be tied to earnings, with year-over-year declines anticipated in aggregate calendar second-quarter EPS across most S&P 500 sectors. S&P Global Market Intelligence data compiled Aug. 7 indicated that with the exception of with the exception of the utilities, healthcare and information technology sectors, the remaining eight of 11 S&P 500 sectors were expected to see declines ranging from 7% within the consumer staples sector, to 169% within the energy sector. However, the S&P 500's ongoing premium valuation to utilities and continued outperformance could reflect investors' expectation of improved economic conditions in the second half of 2020 and further.

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Multi-utilities, led by Avangrid, Inc.Xcel Energy Inc. and Sempra Energy, saw the highest 2021 P/E increase among utility subsectors since July 10, up 5.8% on average.

Avangrid's 2021 P/E rose nearly 14%, to 20.6x — above the multi-utility group's approximate 18.0x average — buoyed by strong stock performance in July, with the shares finishing the month as the water and utility group's top performer despite slightly missing its second-quarter consensus earnings estimate. Xcel Energy outperformed both the the S&P 500 and S&P 500 Utilities by a wide margin between July 10 and Aug. 14 (up 10.9% versus 5.9% and 4.1%, respectively) after reaffirming its 2020 EPS guidance and 5% to 7% long-term EPS and dividend growth target. Within the same time frame, the Sempra Energy shares rose 10.7% and its 2021 S&P Capital IQ consensus EPS estimate rose to $8.00 from $7.95, leaving its 2021 P/E at a below group-average of 16.5x. Of note, Avangrid, Xcel Energy and Sempra carry above-average 2019-2022 estimated compound annual EPS growth relative to the multi-utility group: 6.7%, 6.2% and 7.6%, respectively, versus the broader group's anticipated 2.5% growth.

Wide range of movement seen in electric utility P/Es

Electric utility 2021 P/Es rose marginally owing to a wide disparity of movements between July 10 and Aug. 14, namely Evergy Inc.'s 13.3% decline to 16.7x and FirstEnergy Corp.'s 28.9% decline to 11.2x, versus the group's 16.8x average P/E. Recent negative investor sentiment in the Evergy shares likely reflected the company's decision following a months-long strategic review to pursue a standalone growth plan rather than a stock-for-stock merger; Evergy shares closed nearly 12% in early August on media reports that Evergy would end sales talks and remain independent. For additional detail, see the Aug. 10 Financial Focus report, "Evergy standalone growth strategy looks to deliver higher rate base, EPS growth."

The substantial drop in FirstEnergy's 2021 P/E was precipitated by the U.S. Attorney's Office for the Southern District of Ohio and the Federal Bureau of Investigation's announcement of charges related to more than $60 million in bribes allegedly paid to Ohio House Speaker Larry Householder and his associates to steer a nuclear subsidy bill, House Bill 6, through the state legislature. FirstEnergy management has indicated that the company "acted properly in this matter and we intend to cooperate fully with the investigation to, among other things, ensure our company and our role in supporting House Bill 6 is understood as accurately as possible." For additional detail, see the July 28 RRA Regulatory Focus report, "Ohio nuclear legislation under fire as FirstEnergy reiterates innocence."

Elsewhere, PNM Resources Inc.'s 2021 P/E rose 15% through Aug. 14 primarily on share price appreciation as its 2021 EPS consensus estimate remained virtually unchanged. The company recorded one of the largest year-over-year increases to second-quarter EPS at 48.6% as warmer temperatures in the companies' service territories during the second quarter outweighed the reduced load impacts related to COVID-19.

PPL Corp.'s 2021 P/E rose more than 14% after announcing a planned sale of its U.K. electric distribution assets, the proceeds from which will go toward reducing leverage and improving the company's credit metrics, investments in regulated utility assets or utility acquisitions to drive long-term EPS growth in line with peers, and potentially the return of capital to PPL shareowners through share buybacks. For additional detail, see the Aug. 12 Financial Focus report, "Valuation weakness, tax changes prompt PPL to put UK assets on the block."

The quadrant chart below shows how the Regulatory Research Associates' utility universe looks when comparing the P/E ratio and the estimated long-term earnings growth rate. Energy utility 2021 P/Es have remained largely in the upper left quadrant, suggesting the names could be relatively undervalued considering their lower P/E values and long-term earnings growth potential.

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Performance, earnings growth

The S&P 500 Utilities index narrowed its year-to-date loss to approximately 7% on Aug. 14 from 10.6% on July 10, while the S&P 500 moved back into positive territory on the year. From an earnings perspective, the S&P Global Market Intelligence consensus estimates forecast average EPS growth of approximately 2% in 2020 versus 2019's results across all energy utility sectors. Robust earnings appreciation for the Financial Focus energy utility group is forecast to resume in 2021, with approximately 6.6% growth, followed by a 5.8% increase in 2022.

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Regulatory Research Associates is a group within S&P Global Market Intelligence.

For a complete, searchable listing of RRA's in-depth research and analysis, please go to the S&P Global Market Intelligence Energy Research Library.

Charlotte Cox contributed to this article.

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.

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