Four Trends Power our Utilities Sector Outlook in 2024

The utilities sector took investors on a wild ride, crushing the market in 2022 and getting crushed in 2023. But most of the pain is over, according to Morningstar strategists Travis Miller and Andrew Bischof.

Valuations have ebbed since peaking in early 2020, and fundamentals have improved. Growth outlooks and balance sheets are strong. Nearly every utility is rewarding investors with secure, growing dividends.

Our top picks for electric, gas, and water utilities stocks are well-positioned for 2024. Read on for four trends to watch.

When you download the full utilities sector outlook, you’ll get:

• Renewable energy markets to watch.
• State-specific breakdowns of regulatory trends.
• Our top four stock picks.

Utilities stocks are known for holding steady during economic turmoil. They historically offered stable returns during periods of stock market volatility. Utilities are proving investors can get consistent dividend growth, something that traditional bonds don’t offer.

However, sector growth faces some countercurrents.

Regulatory scrutiny on customer bills and higher interest rates could affect the dividends that investors receive. Investors should consider the specific factors affecting individual utilities stocks.

In the United States, we expect solar and wind generation will surge past coal for the first time in 2024.

While gas remains the leading fuel source, the utilities sector’s investments in renewable energy are growing. Our analysts think solar energy will be the fastest-growing clean energy technology over the next decade.

A few factors could constrain growth. Here’s what our analysts will be watching in the energy and utilities sector:

• Benefits from the 2022 Inflation Reduction Act have started to flow through the clean energy sector. We don't expect any political momentum to reverse the Act's subsidies this year.
• Higher financing costs. U.S. offshore wind developers backed out of several large projects, claiming unanticipated inflation, higher interest rates, and supply chain issues. Large energy storage projects face similar risks.
• Grid capacity. Grid constraints could start limiting renewable energy growth in the Central Plains region, Texas, and California.

The market's higher-for-longer interest rate outlook sunk utilities in 2023.

When interest rates rise, utilities stocks tend to underperform. This is because utilities stocks are capital-intensive, relying on borrowing to fund growth investments. As interest rates increase, so do borrowing costs, putting strain on these businesses.

Higher interest rates will increase costs in 2024 as utilities issue new debt and refinance at higher costs. To recover higher financing costs from customers, utilities will need regulatory signoff on bill increases.

Higher interest rates also make utilities’ dividend yields less attractive for income-focused investors. In 2022, interest rates climbed above utilities’ dividend yield for the first time since 2008.

Now the good news.

In 2024, possible Fed rate cuts represent potential upside. We think utilities’ improving fundamentals—stronger earnings growth, balance sheets, and dividend coverage—will mitigate some interest rate exposure.

PitchBook research digs deeper into utilities company financials, valuations, and comparisons.

U.S. federal elections likely won’t affect the utilities sector.

Despite political rhetoric, carbon emissions have fallen under both Republican and Democratic administrations. We expect coal plant retirements to continue and carbon emissions to fall, regardless of who controls Congress.

But at the local level, regulatory activity could affect utilities stocks in 2024.

Some state regulators continue to approve customer rate increases to fund utilities' aggressive capital investment plans. Other regulators take a tougher approach.

Overall, we believe more regulators are making constructive decisions that support utilities' earnings growth outlooks.

Higher operating, financing, and capital costs drove up utility bills nationwide. This could weigh on energy demand and, ultimately, long-term earnings growth.

About half the average customer’s bill includes energy costs, taxes, and other fees that utilities pass through to customers with no markup. In 2021, electricity prices began accelerating, putting pressure on customers’ utility bills.

However, customers are continuing to see relief from falling natural gas prices. Natural gas demand has remained strong for both residential and electric power. We see no indication that gas is going away anytime soon.

In 2024, artificial intelligence could be a major driver of electricity demand. Areas with surplus renewable energy and low power prices are creating hotbeds of data center growth.

As a result, our latest utilities sector outlook forecasts 1.4% annualized US electricity demand growth through 2032. This is higher than most forecasts and would be the fastest growth in two decades.

But this AI-powered trend may present several considerations in areas such as:

• Utilities rate regulation: While long periods of poor rate regulations hinder a utility’s ability to raise cost-effective capital to maintain the grid, regulators also face political pressure from ratepayers to keep utility bills low. This conflict makes it essential for investors to understand the rate regulation dynamics for each utility. Key regulatory issues to watch include tighter operating cost budgets and rate freezes.
• Reliable energy: Data center developers are targeting areas where the electric grid can accommodate large energy demand without compromising reliability or requiring long lead times for new infrastructure. Adding new data center electricity demand will be a challenge in regions—such as the northeast and southwest—that already have low reserve margins.
• Low-cost energy: Retail electricity prices vary by states and regions based on factors like energy commodity costs, grid efficiency, taxes, and other passthrough costs. Low and stable electricity prices in the southeast and central US give those regions a slight advantage over areas like the northeast and west coast where electricity rates are rising.

Exclusive Morningstar ratings give investors a starting point for analyzing investment opportunities. The Morningstar Rating for Stocks assesses a stock’s current price relative to its fair value estimate.

Investors can dig deeper into dividend stability and growth with timely investment data.

• Dividend per share/earnings per share can indicate relative dividend payout.
• Capital expenditures/depreciation shows capital investment flexibility. While net new investment usually translates into dividend growth, sometimes utilities must retain more earnings to fund investments.
• Average net debt/EBITDA can show financial flexibility. Most utilities must keep leverage below 6 times EBITDA to maintain a healthy dividend.

For our analysts’ four stock picks, download the outlook.