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Valuation Delta Between S&P 500, Utilities Reaches Widest Point Since 2003

After tracking closely in early April ahead of first quarter earnings season, valuations on a stock price-to-earnings plus growth basis between the S&P 500 and S&P 500 Utilities indexes recently reached their widest spread since July 2003, as utilities endured weeks of underperformance while the broad market was thriving, despite a souring outlook for 2020 profits among many cyclical sectors surrounding COVID-19 concerns.

The S&P 500's next-12-months, or NTM, P/E has expanded by more than 15% through May 13 since our April analysis, with the index increasing in value by approximately 1% over that time frame. By comparison, the S&P Utilities' NTM P/E has declined by approximately 10%, with the index value declining by a similar amount between April 9 and May 13. From an earnings perspective, however, utilities have shown relative stability, registering the fewest financial outlook revisions or withdrawals since the advent of the COVID-19 pandemic versus other S&P 500 sectors: more than half of the companies in the S&P 500 have withdrawn or lowered financial guidance over COVID-19, after 19 more companies in the large-cap index cut or suspended their financial projections from May 7 to May 13, according to an S&P Global Market Intelligence analysis, primarily within the industrials, consumer discretionary, technology and health care sectors. As of May 8, the S&P 500 Utilities sector was expected to post a 4.1% rise in year-over-year first quarter EPS versus an expected 11.2% decline among the broader S&P 500 index. For additional detail, see the May 14 Financial Focus report US utilities' Q1 earnings results mixed; electric names see highest EPS growth.

The relative underperformance of utilities since the start of the pandemic is perplexing given the group's generally defensive nature and this year's sharp COVID-19 driven stock market and economic declines. A possible explanation is that investors have broadly "written-off" 2020 earnings and are focusing on an anticipated major improvement in 2021 under the assumption that the economy overwhelming re-opens and returns to a much more normal level of production. This scenario would benefit strong growth areas such as information technology, hence the Nasdaq Composite's comparatively strong performance, and the economically cyclical sectors of the economy more than utilities.

Also of note is the wide disparity in valuation between the S&P 500 and S&P 500 Utilities indices for comparisons dating back to the early 2000s. Recall that the utility sector had gone through a massive transformation in the aftermath of widespread industry restructuring, with many companies failing in the 2001-2002 time frame in their with efforts to diversify into non-familiar and high-risk investments both inside and outside the energy sector. Many companies in the utility sector were financially beaten and valuation differentials with the then more-stable broad market sector was financially substantiated. Such substantiation does not appear warranted in the current financial and economic environment.

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CenterPoint Energy Inc. and Dominion Energy Inc.'s NTM P/Es remained relatively unchanged versus more pronounced declines within the companies' multi-utility peer group and the electric and gas groups, with both stocks outperforming since April 9. CenterPoint, the worst-performing utility stock in the first quarter amid management turnover, a contentious Texas rate case and a dividend cut to stave off potential cash flow issues, on May 7 announced that it formed a board committee to review and evaluate potential strategic options. The company has also secured a $1.4 billion equity investment that it intends to use together with cash proceeds from asset sales to deleverage its balance sheet to strengthen its credit profile. S&P Global Ratings and Moody's dimmed their credit outlooks on CenterPoint in early April, citing cash flow concerns.

The Dominion Energy shares declined approximately 3% between the April 9 and May 13 period, during which the company affirmed its full-year 2020 operating EPS guidance range of $4.25 to $4.60 and its 5% or more post-2020 annual operating EPS growth rate. The company's Virginia utility also announced plans to add about 5,100 MW of offshore wind, nearly 16,000 MW of solar and about 2,700 MW of energy storage to its portfolio through the end of 2035.

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Elsewhere, electric utility NTM P/Es declined 10.6% on average, with PNM Resources Inc. declining by 23% and Portland General Electric Co. down 15%. 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.

Within the gas utility sector, National Fuel Gas Co. was the sole energy utility to see an uptick it its NTM P/E, with shares rising approximately 4% during a period in which NFG reported fiscal second quarter EPS that surpassed consensus earnings estimates, and announced a $541 million transaction to purchase Appalachian shale gas assets that are expected to boost EPS and free cash flow. Within the broader gas utility sector, NTM P/Es declined 9% on average, led lower by Southwest Gas Holdings Inc. and ONE Gas Inc.

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. RRA is a group within S&P Global Market Intelligence. Since our most recent valuation analysis April 9, utility NTM P/Es have shifted to the upper left quadrant, likely owing to recent stock underperformance. Large-cap utility NextEra Energy Inc. remains in the upper right quadrant, as well as Eversource Energy and Xcel Energy Inc. Long-term EPS outlooks for the three energy utility sub-groups have held steady since April, suggesting swings in the stock market and changes in individual company circumstances that have impacted stock prices have been the primary driver of NTM P/E valuations in recent weeks.

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Performance, earnings growth

Through May 13, the S&P 500 Utilities lagged with a 15.1% decline versus the S&P 500's 12.7% year-to-date decline, compared with the indices respective 5.8% and 13.7% declines through April 9. From an earnings perspective, the S&P Global Market Intelligence consensus estimates predict average EPS growth of approximately 4% in 2020 versus 2019's results across all energy utility sectors, when excluding outliers CenterPoint and PG&E Corp. With the broader economic effects of the coronavirus pandemic just beginning in March, most utilities' first-quarter results did not reflect significant pandemic-related impacts — adjusted earnings for the companies in the energy and water utility universe were up 2.9% year over year. Management teams expressed varying levels of uncertainty regarding the remainder of 2020. Despite many companies reporting that commercial and industrial sales fell in April, most management teams affirmed existing earnings guidance ranges. Only a couple of utilities, including American Electric Power Co. Inc., significantly adjusted their planned capital expenditures for the year.

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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.

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