Bond Market’s Post-Trump Fit Means More Pain for Utilities: BofA

  • Firms that have boosted returns by borrowing are most at risk
  • Strong dollar also a challenge for utility companies overseas

Volatility in the bond market may push utility valuations back toward the levels of 2015, a recipe for pain in a group where a second-half selloff has been exacerbated by the election of Donald Trump.

That’s according to Bank of America Merrill Lynch, which downgraded seven stocks Tuesday, saying their drop since Election Day isn’t enough to reflect the risk of rising bond yields. Power companies, which have been steadily falling since June amid a rotation out of defensive stocks, have lost more than 5 percent since Trump’s victory in a lockstep reaction with fixed-income.

“Utilities have greater risk skew to the downside than to the upside at present,” a group of Bank of America Merrill Lynch analysts led by Brian Chin wrote in a client note. “Our lowered view of utility valuations dovetails with our currency strategists’ view that fiscal stimulus post-election is more likely to push long term interest rates higher.”

Bank of America Merrill Lynch forecasts that 10-year Treasuries will yield 2.65 percent by the end of 2017, about 34 basis points higher than its level at 2:18 p.m. in New York. Higher bond rates usually depress utility valuations by making their dividends less competitive.

Bank of America Merrill Lynch downgraded AES Corp., Duke Energy, Entergy Corp. and Portland General Electric Co. to underperform from neutral. It also lowered its ratings on Calpine Corp., NRG Energy Inc. and PPL Corp. to neutral from outperform. The firm upgraded DTE Energy Co. to buy and Pinnacle West Capital Corp. to neutral.

Companies such as Duke Energy Corp., Consolidated Edison Inc. and Southern Co. are at particular risk after using leverage to boost share prices and growth, the firm said.

The analysts also stressed caution on utility stocks like PPL and AES, which have high overseas exposure. If the dollar rises along with interest rates, as forecast by Bank of America Merrill Lynch strategists, companies with international operations could be negatively affected as earnings are repatriated.

The price-earnings ratio on utility stocks in the S&P 500 has already declined 15 percent to 16.6 since reaching the highest since 2000 July. The measure is still 12 percent higher than its bull market average. The sector will be trading at 15.5 times profit two years from now, according to a forecast compiled by Bloomberg.

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