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Accelerating Rate Base Growth

Sector & Sovereign Research

July 9, 2019

Accelerating Capex Drives Faster Utility Rate Base Growth Well into the Next Decade: Our Updated Rate Base, ROE and Valuation Matrix Favors FE, AEP, AGR & PEG

In this research report, we present our updated forecast of rate base growth for each of the publicly traded utilities, and roll forward our forecasts to include 2023. We expect the regulated utility sector to realize 7.3% average annual growth in electric plant rate base over the next five years (2019-2023), up from 7.0% p.a. over the last five years (Exhibits 4 & 5). Capital expenditures planned for 2019-2022 have increased by 10% compared to this time last year, rising by 17% in generation, 8% in distribution and 5% increase in transmission -- a testament to the investment opportunities facing electric utilities as they replace aging power plants, transition to renewable generation, and expand and harden power grids to meet customer growth and enhance system reliability. Allowing for historical rates of equity issuance during prior periods of comparable rate base growth, we expect 7.3% annual growth in rate base to drive ~5.3% to 5.8% growth in earnings per share. Given the sector’s 3.1% dividend yield, regulated utilities offer the prospect of ~8.4 to 8.9% average annual returns, competitive with prospective returns on the S&P 500. Given the sector’s three-year beta of 0.3x (Exhibit 7), adding regulated utility stocks to equity portfolios can reduce volatility without sacrificing expected returns. The primary risk faced by utility investors is higher long-term interest rates, eroding the relative PE of the sector. Our stock selection matrix, which weighs relative valuation, forecast rate base growth, and historical earned ROE, favors FE, AEP, AGR and PEG (Exhibit 1). Screening unfavorably on these metrics are ALE, PNM and POR. Attractively valued utilities that combined above average rate base growth and below average ROEs include D and ETR, offering the potential for outperformance if they can improve their ROEs.

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