Andrew Bischof: Utilities are rich, with the median utility trading about 10% above our fair value estimates. Low interest rates, an uncertain political environment, and a bevy of other factors have pushed utility valuations higher. Utility fundamentals remain strong, with good growth prospects, secure dividends, and sound balance sheets. However, with utility valuations, investors' long-term capital gains are at risk, even if utilities execute on their 5%-7% earnings and dividend growth. However, when compared to Treasuries, utilities remain an attractive source of yield income for investors. Even with elevated valuations, the spread between utilities' dividend yields and the 10-year U.S. Treasury remain above historical parity, with the spread widening to over 170 basis points. We almost reached parity late last year.
For dividend investors, we think NextEra Energy, Sempra Energy, and American Water Works have the highest dividend-growth potential. NextEra Energy's growth is driven by both regulated and contracted renewable opportunities, leading to nearly 14% dividend growth and 9% earnings growth. Sempra Energy's LNG opportunities and regulated infrastructure projects support our 11% dividend growth. Low payout ratios and continued consolidation among municipal utilities support American Water Works' attractive dividend growth. We forecast Southern Co. and Dominion Energy will be dividend-growth laggards, constrained by high payout ratios and capital investment needs. Finally, PPL's struggles in the United Kingdom will probably result in no dividend growth and could lead to a dividend cut after the next regulatory outcome.
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Andrew Bischof does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.