Financial turmoil in March amid banking fears and a “flight to safety” in equity markets have left some major utility stocks trading at “discounted levels,” analysts at Morgan Stanley said Tuesday.
“Recent moves in rates and inflation are supportive of utilities, but going forward we think performance will be more heavily influenced by the earnings growth outlook for the market along with the trend in recession risk factors,” the firm wrote in a research note.
Morgan Stanley’s equity strategy team “remains overweight utilities,” the firm said, citing “elevated but decelerating inflation” and softening interest rates, among other factors.
Looking back 30 years, the firm said the utilities sector and the energy sector show “positive relative returns” around recessions. And utilities are “one of the few outperformers in the period right after a recession commences.” Utilities tend to most outperform the market in the year before a recession and three months after one starts, according to the research note.
It remains unclear if the United States is in a recession, but the month of March was troubling for the financial sector. The collapse of Silicon Valley Bank left utilities relatively unscathed but led to uncertainty in the residential and community solar sectors. The CEO of Arcadia, the largest domestic manager of community solar projects, said the bank’s collapse will “have an impact on the broader industry.”
Nevertheless, the high demand for renewables could help to fuel a rise in some utilities’ stock price, Morgan Stanley said.
The utilities sector outperformed the S&P 500 in March, but within the group a few lagging utilities may be ripe for opportunity, the firm said.
Utility and power generator AES has underperformed its peers in recent weeks, but the firm said concerns over banking industry challenges and a lower 2023 outlook than anticipated “are overdone.”
“Demand for renewables remains very high and AES has a robust pipeline. We don't expect challenges with access to debt or tax equity capital to finance renewables projects,” analysts wrote. The utility’s stock has more than 40% upside over the next 12-18 months, analysts wrote.
DTE Energy’s utility subsidiary has proposed to spend about $9 billion to add 4,400 MW of solar, 1,000 MW of wind and 760 MW of battery storage in the next decade. DTE trades at a discount to its peers based on price-earnings metrics, but Morgan Stanley analysts say they believe that gap is “unwarranted and will reverse,” and said they expect a “supportive” rate decision from the Michigan Public Service Commission in the fourth quarter of the year to give the company a boost.
Exelon in February raised its four-year capital spending plan to more than $30 billion and said it anticipates significant annual growth in its rate base. Progress on rate cases and spending plans will bring “additional clarity to the earnings and growth outlook,” Morgan Stanley said. The firm also sees a “clear path to achieving [earnings per share] results above the midpoint of the 6-8% growth guidance.”
Morgan Stanley sees potential for share price increases of two other utilities that have underperformed of late.
For Public Service Enterprise Group, “we see attractive upside looking at several angles” including the utility’s nuclear business. The New Jersey utility said in February it is considering “small but important value-added investments” at its nuclear plants that will capitalize on production tax credits in the Inflation Reduction Act.
And PPL shares have struggled recently, trading at a 4% discount to peers on some concern around Kentucky legislation requiring regulator approval before utilities can shutter coal plants.
“The stock now trades at a 4% discount, while we think the company has a strong case to move forward with the
planned closures and replacements of its Kentucky coal plants, along with no rate case risk through 2025,and a strong balance sheet with no equity needs,” Morgan Stanley said.