Domestic-focused and regulated utility electric power companies supply basic-necessity electricity and its demand rarely fluctuates during economic cycles. These stocks are favored by investors for their stability and ability to payout regular dividend to their shareholders.
With an increasing focus on emission, these electric utilities are investing in plants that generate electricity with low amounts of emissions, and are targeting the improvement and upgrading transmission and distribution networks.
Despite the above drawbacks, cost control, customer growth and requirement of electricity in all spheres of life are the driving forces behind the success and stable performance of the electric power companies.
Looking at shareholder returns over the past year, it appears that the broader economic recovery wasn’t enough for enhancing investors’ confidence in the industry’s growth prospect. And this is despite the fact that the domestic-focused electric utilities enjoy steady demand and are not too much dependent on the movement in economic trend.
Since electric power companies have a lot of debt on their balance sheets, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio.
This is because the valuation metric considers not just equity but also the level of debt. For capital-intensive coal companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structure and ignores the effect of noncash expenses.
The valuation of the industry still appears cheap, in comparison to the market at large. The industry currently has a trailing 12-month EV/EBITDA ratio of 10.35, which is above the median level of 10.23.
The trailing 12-month EV/EBITDA ratio for the Zacks S&P 500 Composite is 11.92 and the median level is 11.50.
Utility Electric Power companies are among the safest investment bets, due to their domestic focus and regulated nature of operations. However, they still have their share of weaknesses. Stringent emission rules, weather variation and increased debt loads amid rising interest rates are major concerns for such entities.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The valuation analysis above shows that the Utility Electric Power industry is presently trading cheaper than the broader sector and the Zacks S&P 500 composite.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance is its earnings outlook. Empirical research shows that the earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.