Morgan Stanley Issues Industrywide Utilities Update

Stock market volatility has resulted in the utilities sector trading lower by 8 percent in 2018, according to Morgan Stanley — creating some buying opportunities for investors, as well as a call for investors to revise their bullish stance on one name.

The Analyst

Morgan Stanley's Stephen Byrd made the following rating changes:

• Xcel Energy Inc XEL upgraded from Equal-weight to Overweight with a price target lowered from $49 to $48.
• Pinnacle West Capital Corporation PNW upgraded from Underweight to Equal-weight with a price target lowered from $85 to $79.
• Eversource Energy ES downgraded from Overweight to Equal-weight with a price target lowered from $63 to $60.

Tactical Opportunity

Morgan Stanley's chief equity strategist Michael Wilson recently upgraded the entire utilities sector to Overweight, which prompted Byrd to revisit individual companies. According to Wilson, investors are faced with a "tactical opportunity" amid expectations for a slowdown in the pace of interest rate hikes and tax revisions driving positive earnings revisions.

Byrd said he isn't sufficiently convinced that the longer-term return profile for utilities is attractive enough versus the broader market to justify an upgrade — but that doesn't mean the group is without standouts. 

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Xcel Energy

Xcel Energy serves electric, natural gas, and other customers across eight states and is able to leverage low-cost wind to increase capital spending while simultaneously lower customer bills and generating energy in a sustainable fashion, Byrd said. As a result, the company boasts superior earnings growth versus its peers and also faces fewer regulatory hurdles, the analyst said. 

Xcel Energy's stock has underperformed the broader index by 190 basis points since the start of 2018, which creates an "attractive entry point" amid a better risk-to-reward profile, Byrd said. 

Eversource Energy

Eversource Energy's outlook is now "much less certain" after the company's Northern Pass Transmission project was denied by the New Hampshire Site Evaluation Committee, Byrd said. The project was intended to transport power from Quebec, Canada to Massachusetts; it would have represented 8 percent of Eversource's 2020 earnings per share and now calls into question the company's 5-to-7 percent EPS growth guidance, the analyst said. 

Eversource Energy could make use of share buybacks to grow its EPS, but anything beyond 5-percent growth is "less certain," although not entirely impossible, he said. Morgan Stanley's revised price target implies a 5-percent upside in the stock, a return level that is in-line with other Equal-weight stocks under coverage.

Pinnacle West

Pinnacle West's stock has not only underperformed the broader utilities group by 280 basis points since the start of 2018, but is now trading at a 5-percent discount to its peers on consensus earnings, Byrd said. The risk-to-reward profile has improved for the company, which operates a utility with a single-state jurisdiction of Arizona.

Sales growth trends in Arizona have come in better than expected of late, and the regulatory risk in the state is "low" over the next one to two years, the analyst said. The company is among the few utilities whose service territory is seeing demand growth, and electric sales growth is expected to rise 0.5 to 1.5 percent per year, according to Morgan Stanley. 

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