Merrill Lynch Much More Optimistic for Upside in Major Utilities in 2019 and Beyond

Many investors flocked into the utility sector during and after the Great Recession. After all, this was a safety and defensive investing strategy, first and foremost. But the sector also offered investors high dividend yields at a time when interest rates were next to zero. But now that interest rates have risen handily, those interest rates have started to tick lower on the long-end of the yield curve. Some investors might be thinking that the safety and income from utilities already has seen its upside.

Merrill Lynch does not feel that way at all. During the week of March 29, 2019, the firm increased its price objectives on many top utility stocks in its coverage universe, and it has Buy ratings on many of these names. While not all the utility shares come with Buy ratings, even some of the more cautious names saw their price objectives raised substantially.

Here 24/7 Wall St. offers a brief review of each company, along with the respective hikes in the price objective and the 52-week trading ranges and Refinitiv consensus analyst target prices.

The electric utilities team at Merrill Lynch is made up of seven named analysts making the reports. With several utility companies embarking on substantial renewable build-outs across the firm’s coverage universe, the firm examined the nuances of tax credits and the major players that utilize various recognition methods. The firm does note that it continues to see tax credit valuation as an evolving debate and only a portion of utility investors have adequately delved into the subject.

While the views are hard to see universally at each and every utility, Merrill Lynch looked into the recognition of investment tax credits (ITCs) for solar and offshore wind to allow for more flexibility for these companies to elect to recognize ITCs in earnings over a shorter or longer duration. The added flexibility could be viewed as advantageous, but the firm also thinks it should be examined more diligently by investors.

The Merrill Lynch report also looked at how investors should value the tax equity contribution in overall utility earnings rather than based on traditional P/E (price-to-earnings) ratio analysis. The report said:

While many investors traditionally view utility earnings on a P/E basis, applying the same methodology to tax credits can be misleading given the lack of transparency and eventual sun-setting of incentives for renewables. With tax credits frequently taken on a very short duration basis, all of the earnings power of assets is effectively accelerated into the initial years of the structure. Thus, we caution from putting a multiple on these earnings as they are effectively interest expense tied to the tax equity, and instead encourage a DCF approach. We believe reconciling the full extent of earnings power through this method rather than applying a P/E multiple to earnings that remain generally opaque is more appropriate… We see proper value less than half (~45%) of that that would be applied on a straight P/E basis. As renewable development continues to proliferate, we believe these considerations will become increasingly important when assigning value to tax credits in earnings that are generally less in quality.

Ameren Corp. (NYSE: AEE) is a public utility holding company operating in electricity and natural gas throughout Middle America. Merrill Lynch raised its price objective to $77 from $70 (versus a $73.46 prior close). Ameren has a 2.5% dividend yield, a 52-week range of $55.01 to $74.91, and a consensus price target of $70.78.

American Electric Power Co. Inc. (NYSE: AEP) is a top utility with millions of customers in middle America as well. The firm raised its price objective to $94 from $90 (versus an $83.79 close). AEP has a 3.1% dividend yield, and the company historically has been one of the most vocal dividend supporters of all utilities. Merrill Lynch has a Buy rating and noted that AEP acquired new wind through Sempra and is likely in the early stages given roughly $1 billion remaining in its renewable capex guidance. The 52-week range is $62.71 to $86.10, and the consensus price target is $82.75.

American Water Works Co. Inc. (NYSE: AWK), America’s leading water utility, saw its price objective raised to $114 from $103 (versus a $104.32 close). Merrill Lynch has a Neutral rating despite that big upside. Its dividend yield is 1.7%. The 52-week range is $77.73 to $107.71, and the consensus price target is $103.46.

Avangrid Inc. (NYSE: AGR) operates a natural gas and renewable energy utility company in the northeastern part of the United States. Merrill Lynch has a Neutral rating but raised its price objective to $54 from $52 (versus a $50.01 close) in a sum-of-the-parts valuation, compared with the most recent closing price of $50.01. The stock has a dividend yield of 3.5%. The 52-week range is $45.81 to $54.55, and the consensus price target is $50.38.

Black Hills Corp. (NYSE: BKH) is an electric and natural gas utility company with customers in Colorado, Montana, South Dakota and Wyoming. Its price objective was raised to $75 from $71, along with a Neutral rating, and it comes with a 2.7% dividend yield. The 52-week range is $52.63 to $74.77. The consensus price target is $68.67.

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