The year hasn't been kind to utility stocks, as they continue to face significant challenges. However, this slump has created intriguing opportunities for investors, including the undervalued Avista.
The Utilities Select Sector SPDR exchange-traded fund (XLU) has experienced a 12% decline over the past year, resulting in a loss of popularity among investors. Initially viewed as safe havens, utility stocks were abandoned as recession fears dissipated and riskier options gained favor. Additionally, the rise in interest rates dampened the attractiveness of utilities' dividend yields. More recently, the occurrence of wildfires in Hawaii and elsewhere has raised concerns about potential legal liabilities for utility companies, adding further pressure on their share prices.
Unfortunately, this selling frenzy has become excessive. The Utilities ETF now trades at less than 16 times its 12-month forward earnings, significantly lower than the 20.41 multiple observed a year ago - its lowest level since April 2020. In addition, it currently trades at a discount to the S&P 500 index, while historically commanding a premium. Simply put, utilities couldn't be cheaper at this point.
Contrary to the prevailing pessimism, worries surrounding utilities may be exaggerated, and their earnings potential could turn out to be much stronger than expected. These companies have been rapidly replacing old power plants with clean-energy alternatives. As a result, their "rate base" - which represents the equity in these assets on which they earn a fixed return - continues to grow. This is undoubtedly a boon for profits as assets increase, giving rise to higher earnings.
For investors seeking a diversified approach, the Utilities ETF offers an ideal solution. With exposure to 30 stocks and charging a minimal management fee of 0.1%, it effectively spreads out the risk. However, those interested in investing in individual stocks may find Avista (AVA) particularly appealing. With a year-to-date decline of over 25%, Avista currently trades at a modest multiple of approximately 13.7 times earnings - its lowest level in over a decade. At this price, Avista presents a compelling value proposition.
In conclusion, despite the challenges facing utility stocks, there are hidden gems waiting to be discovered by discerning investors. The sector's undervaluation coupled with potential earnings growth makes it an attractive proposition. Whether through the Utilities ETF or individual stocks like Avista, there are ample opportunities for investors to capitalize on this market dislocation.
The Future Looks Promising for AVA Stock
There are a few factors that have been holding back AVA stock, but these factors are expected to reverse soon. In recent years, the company has been less assertive in requesting rate base increases due to its attempt to sell itself to Canadian utility Hydro One. However, this deal was denied, and now Avista, operating in Washington, Idaho, and Oregon, needs to catch up. Despite this setback, analysts predict that total assets will grow by a modest 3% this year, reaching just under $7.7 billion. Return on equity is also expected to increase to 7.1%, although still lower than the 10.3% recorded in 2019.
Looking into the future, Avista will benefit from favorable settlements with states, allowing it to raise prices and achieve higher earnings growth. Oregon, for example, will permit a rate base increase close to 5% and a return on equity of 9.5% starting in 2024. As a result, the company's total return on equity is projected to rise to 7.4%, with assets increasing to nearly $7.9 billion. This growth in earnings will surpass 8% and reach $2.47 per share.
As investors become more confident about the potential for higher profits, they are also willing to pay a higher multiple for those earnings. Christopher Ellinghaus, an analyst at Siebert Williams Shank, estimates a price target of $50 by using an 18.5 times multiple on his projected 2025 earnings per share. This represents approximately a 50% gain from the stock's current price of $33.
According to Ellinghaus, "AVA shares have reached an absurd level." This assessment presents an opportunity for investors to consider entering the market.