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Utilities Should Be a Little Cheaper

Utility companies have generally been thought of as relatively stable, safe investments due to their low valuation multiples and generous dividend yields. Lately, however, the sector seems to have gotten much more expensive than it has been in recent history. One example in particular that seems to have gotten a little bit ahead of itself is NextEra Energy (NYSE: NEE  ) , an excellent company whose stock simply doesn't offer the same compelling value that it used to.

About NextEra Energy
One of the largest North American power companies, NextEra has over 42,000 mw of generating capacity. It is a holding company for several power providers, most notably for Florida Power & Light Co, whose service area covers almost the entire east coast of Florida. 

Most of the company's energy is generated from natural gas (73%) and nuclear (15%) with smaller contributions from sources like coal and oil. The company has benefited recently from the improving housing market (Florida's market was one of the hardest-hit by the foreclosure crisis), but utilities are becoming less attractive to investors as the current loose monetary policy favors riskier stocks than utilities.

NextEra and others like it: how much will you pay?
Shares of NextEra have risen by about 25% so far in 2013 due to the reasons indicated above, as well as the improving stock market in general. This translates to a valuation multiple 17.3 times this year's expected earnings. As far as growth is concerned, revenue growth has been pretty flat for a while now, and the same can be said for earnings. So far, the current valuation doesn't really seem to be justified.

Data Source: TD Ameritrade

This seems to be in line with peers, which indicates that NextEra isn't particularly over/undervalued relative to other companies like it; that this is simply how the electric utilities sector is valued right now.

For example, Northeast Utilities (NYSE: ES  ) , which serves customers in Connecticut, Massachusetts, and New Hampshire, trades for a similar valuation of 16.9 times this year's expected earnings per share. Earnings are expected to grow by a slow and steady rate of 5% annually for the next three years, according to Standard & Poor's, and the company's historical growth is similar to that of NextEra.

NiSource (NYSE: NI  ) is yet another good example of a utility that has gotten ahead of itself. Since 2010, shares of NiSource have risen linearly from about $15 per share to around $32 today. At the current price levels, NiSource looks very expensive at 20.3 times current year earnings. Although the company's 8% forward growth rate is slightly better than the other two, the current valuation multiple is simply not justified.

These lofty valuations have done a number on the companies' dividend yields. NiSource now yields 3.09% annually, whereas just a year ago, the yield was right around 4%. A similar statement can be made for Northeast Utilities, which yields about 3.4% annually

History tells another story
As far as NextEra is concerned, shares currently yield 3.07% annually, which is pretty good when compared to the average S&P 500 dividend payer, but well under the historical average for a utility like this. In fact, when looking at NextEra's average yield over the past decade, it becomes clearer just how overvalued the company (and sector) is at the current share prices.

Data from TD Ameritrade

In fact, NextEra's price is so inflated right now that the only time the yield was less was in 2007, at the height of the "energy bubble."  

So, should I sell or hold on?
Historically, utilities have provided safe yields in the 4% range and have not been considered growth stocks. However, they have certainly been behaving like growth companies over the past couple of years. 

As people begin to shift their money into riskier equities, eventually shares of utility companies will fall until their dividend yields become compelling again. The company's 10-year average dividend yield is 3.52%, so that would be a good point to begin to consider NextEra again. With the current dividend, this would imply a share price of $75, or about 12% below the current price, before NextEra and most of the utility sector would be worth buying again.

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Related Tickers

9/26/2016 4:03 PM
ES $56.34 Up +0.11 +0.20%
Northeast Utilitie… CAPS Rating: ***
NEE $126.23 Down -0.52 -0.41%
NextEra Energy CAPS Rating: ***
NI $25.10 Down -0.01 -0.04%
NiSource CAPS Rating: *****