With Utilities Valuations Looking Full, Which Names Are Still A Buy?

The Utilities SPDR (ETF) XLU is up more than 10 percent so far in 2017, but utility stocks may have finally exhausted their positive momentum. Goldman Sachs analyst Michael Lapides has downgraded the utilities sector from Neutral to Cautious and says valuation is becoming a concern.

Absolute PE ratios in the utility sector are back at peak cyclical levels, and relative valuation metrics compared to the rest of the S&P 500 are also near peak levels, Lapides wrote in the downgrade note. Finally, despite the outperformance in the market, earnings growth remains in the typical range.

“With the utility sector index roughly 10% higher than YE 2016 levels and having outperformed the S& 500 by 1% (excluding dividends) and 2% (including dividends), we become bearish on valuation,” Lapides wrote.

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In terms of specific stocks, Goldman downgraded American Electric Power Company Inc AEP from Buy to Neutral and WEC Energy Group Inc WEC and Ameren Corp AEE from Neutral to Sell. For American Electric, Goldman is concerned over potential multiple contraction. For WEC and Ameren, the concern is primarily about the companies’ ability to meet earnings expectations, especially in 2019.

Still, despite the bearish sentiment on the utility sector as a whole, there are pockets of opportunity available for investors. Goldman has upgraded PPL Corp PPL from Sell to Hold and Duke Energy Corp DUK from Neutral to Buy. Duke’s UK business segment could provide a catalyst for the stock, which could also benefit from lower currency risk, Lapides wrote.

In addition to Duke, Goldman has Buy ratings on the following utility stocks as well:

• FirstEnergy Corp. FE
• Public Service Enterprise Group Inc. PEG
• PG&E Corporation PCG