Scotia Capital analysts Andrew Weisel and Robert Hope see valuations for North American utility and power companies as “modestly attractive” heading into earnings season.
“We expect utilities to remain out of favor for the next 3-6 months, before gaining defensive appeal around mid-2024,” they said. “Investor sentiment appears to be somewhere in between apathy and negativity, in our view. Increasing bullishness around the macroeconomy, coupled with a more hawkish sentiment around interest rates, are keeping investors away from this sleepy, yield-sensitive sector. Consensus EPS forecasts for the S&P 500 now call for year-over-year growth of 12-13 per cent in 2024-2026. By contrast, consensus forecasts for utilities call for 7-8 per cent in all three years — quite strong by historical standards and attractively stable, but notably slower growth than the market overall.
“Moreover, given the severe recent volatility and sizable underperformance in 2023, the stocks’ defensive appeal probably isn’t what it was just three months ago. Seasonality likely won’t help either, as defensive sectors like utilities are often weak in Januarys and Februarys as investors psychologically seem more likely to take big swings, knowing that they have 10 months to make up for any potential mistakes. That said, we expect utilities and defensives to regain some appeal as we enter 2Q24 as political noise around the U.S. elections ramps up. We expect a lot of headline risk during the 2024 election cycle, which can bring volatility and uncertainty.”
In a research report released Wednesday titled No Doubt the Stocks Are Cheap, but Will Anyone Notice?, the analyst increased their target prices for stocks in the sector by an average of 4 per cent after rolling forward their valuations to fiscal 2026. They also reiterated their “overweight” stance on the sector while acknowledging sentiment “remains depressed.”
“While bond yields have moderated since the fall, we keep our anchor P/E unchanged as it is in line with our multivariable regression-implied ‘fair value’ of approximately 15.3 times,” they said. “Both Canadian and U.S. utilities look reasonably priced vs. our regression, but continue to trade at wide P/E discounts vs. the S&P 500 (more than 20 per cent). Overall, we see sentiment as being tepid for the group as investors seem more upbeat about a soft-landing scenario. However, we believe their defensive appeal could increase mid-year as U.S. elections add political noise, not to mention Scotia’s Strategy team seeing the market as being overbought. Fundamentally, we remain bullish on the long-term earnings outlook of the group given the numerous tailwinds driving strong rate base growth, including electrification, renewables, and increasing data center load.”
Mr. Hope recommends two Canadian stocks in the sector:
* AltaGas Ltd. ( “sector outperform”) with a $33 target, up from $31. Average: $32.67.
“AltaGas is our favourite utility stock as we see it benefitting from: (1) strong utility growth, (2) improving balance sheet and easy-to-execute financing plan, (3) increasingly visible and strengthening midstream growth outlook, and (4) an attractive valuation,” he said. “There are numerous opportunities in front of its Utility business which are driving an above average rate base growth outlook (8-per-cent CAGR out to 2028), while Midstream growth appears to be accelerating. We could see several Midstream projects sanctioned in 2024, including the Ridley Island Energy Export Facility (REEF) as well as smaller expansions or debottlenecks, which are not included in our estimates or valuation.”