Power & Utility sector outlook: valuations likely to continue to fall as market conditions shift, according to Ernst & Young LLP

Jul 25, 2013, 12:00 ET from Ernst & Young LLP

NEW YORK, July 25, 2013 /PRNewswire/ -- US Power & Utility valuations, which despite a recent pullback remain well above 10-year historical averages, are not sustainable in the long run, according to a new report by Ernst & Young LLP's Power & Utilities practice.

The report, The great yield rush: A closer look at total shareholder return in the US Power & Utilities sector , asserts that valuations are likely to continue to drop as the sector grapples with shifting market conditions. The recent pullback was sparked by speculation that the Federal Reserve will taper its bond-buying program before the end of the year, a move that would cause interest rates to rise.

"The years of significant capital inflows helping to drive shareholder returns based upon market uncertainty are over," said Joseph Fontana, EY Global Transactions Power & Utilities Leader. "In the years to come investors will reward those utilities that can deliver steady dividends and credible growth prospects in the face of industry transition."

In this economic climate, investors in search of better returns will leave the relative safety of the power & utilities sector in favor of higher-growth potential in the financials, technology and consumer discretionary sectors, as well as rising fixed income securities, according to the report. At the same time, the forecasted anemic electricity demand over the next two decades, combined with significant capital investment requirements, will place pressure on utilities' ability to continue delivering attractive returns.

The EY report highlights several strategies that have developed among sector participants. Some utilities are striving to improve operations and earn maximum allowable ROEs, while at the same seeking growth through capital investments in their regulated businesses. Others are looking to reduce risk by disposing of competitive generation or acquiring additional regulated businesses.

The EY report also examines total shareholder return for the "EY 50" – the largest 50 US utilities by market capitalization – and breaks down total performance by utility segment.

According the EY report, the valuation of power & utility stocks rose in recent years as investors pursued higher yields amid a low interest rate environment. However, if the economy improves as forecasted, the Federal Reserve said it will reduce its bond-buying program, leading to higher long-term interest rates. Investors, growing in confidence, could suddenly consider utilities overvalued.

Click here to download the paper.

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SOURCE Ernst & Young LLP