Morningstar - Q1 2023 - 66

Investors
Electrifying Opportunities
Utilities will drive the clean energy
transition.
SECTOR RAP
Laura Lallos
The staid utilities sector presents an exciting
growth opportunity. As Morningstar Research
Services' Andrew Bischof and Travis Miller
explained in a recent Utilities Observer, electricity
demand is set to grow faster during the next
decade than it has in 20 years. " Our new forecast
is more bullish than most forecasts, " they
write. " We think others underestimate the speed
and scale of the U.S. clean energy transition. " 1
As states and the federal government set
goals to reduce carbon emissions, utilities will
be key to achieving them.
Meanwhile, as 2022 drew to a close, utilities
stock valuations were as attractive as they'd been
in years, their dividend yields were back up
to long-term averages, and balance sheets were
stronger than ever.2
Travis Miller: The interest-rates dynamic has been
driving the utilities sector performance for a
lot of the year. Utilities have been one of the best
yield investments for more than a decade,
and that's changed abruptly as interest rates
started moving up. September was a revaluation
of the sector and a realization that utilities
are no longer necessarily an income investment.
Now, they're increasingly a growth investment.
I spoke with Miller and Bischof
about why they are optimistic about the sector,
and which picks are today's standouts. Our
discussion reflects conditions and valuations as of
Dec. 6. It has been edited for length and clarity.
Laura Lallos: To set the scene, utilities had a
dramatic performance pattern in 2022-sharply up
until September, then a selloff. What happened?
Travis Miller is an energy and
utilities strategist at Morningstar
Research Services LLC.
Lallos: They had also been seen as a safe haven.
Miller: In addition to the attractive yields
they've offered over the last decade, they've also
been a hedge against recession fears, especially
more recently. The debate in the market
around whether we're going into a recession has
also given utilities a relative boost this year.
Utilities are outperforming by 17 percentage
points this year [as of Dec. 6]. They are up about
1%, including dividends, while the market
is down about 16%. If that holds, that will be the
largest outperformance since 2000, so more
than 20 years.
Lallos: At the same time, because they gave up some
of that performance, it sounds like there are some
great values here, also for the first time in a long time.
Miller: We think that combination of growth
and a still fairly attractive yield offer a good
total return for investors in utilities. The utilities
that we see with good growth prospects and
dividend yields near 4% are the ones that
we think are really attractive for long-run investors.
Growth is becoming the big variable there.
Since interest rates have moved up, the
yield properties are less attractive. But the growth
potential has become more attractive given
the macro trends toward electrification and toward
clean energy.
Andrew Bischof, CFA, CPA, is
a utilities strategist at Morningstar
Research Services LLC.
Andrew Bischof: I think some of the volatility
you've seen year to date reflects a little bit
of a question around renewable growth. We
started out the year with some uncertainty around
tariff policy. Then you had the Inflation
Reduction Act [or IRA, which allocated money for
reducing carbon emissions]. I think that was
a surprise for many in the industry. It provided legs
for long-term growth, at least on the clean
energy side, for utilities.
If you take a broader look, utilities will play
a key role in helping reduce as much as
75% of total energy carbon emissions. The IRA
provided benefits that helped reduce the
inflationary impacts of some of these capital
programs. And then we see a lot of growth
for utilities as we get more EVs onto the grid-
not only growth from the electricity demand,
but from the underlying transmission and
distribution investment that you'll need to support
those vehicles.
Lallos: Investors don't necessarily think of utilities
and growth in the same sentence. Is this an
unprecedented environment for utilities?
Miller: Utilities are never going to rival tech
companies or biotech companies in terms of
growth. But this is the best utilities growth
environment that we've seen in decades. When
you combine those big macro themes of
electrification and clean energy, we're seeing
utilities with growth prospects that we haven't
seen in many, many, many years. And these
aren't just growth prospects for the next year or
two. This is growth that we think can last
for a decade or more. A lot of the clean energy
goals and the electrification goals out there
1 Miller, T. & Bischof, A. 2022. " Electrifying the U.S.: Utilities Control the Path to Decarbonization. " Morningstar. September.
2 Miller, T. & Bischof, A. 2022. " Can Utilities Get Up From Their Fall? Utilities' Dividends Offer Investors a Crutch Going Forward. " Morningstar. November.
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