Green Energy Demand Is Recharging European Utilities. 4 Stocks to Consider.
Key Points
- European utility stocks gained 18% this year, outperforming U.S. peers’ 10%, and are valued lower than their U.S. counterparts.
- Electrification and green energy are increasing power demand, necessitating grid investments.
- European grid operators’ capital expenditures are creating debt risks, compounded by rising interest rates.
Utility stocks are great again. In Europe. Driven by the green energy transition.
While U.S. power and light providers steal headlines with data center superprojects and the proposed megamerger between NextEra Energy and Dominion Energy, Old World cousins are outperforming. The MSCI Europe Utilities index has gained 18% this year; its U.S. counterpart, 10%.
An Iran war–driven spike in natural-gas prices delivered some windfall earnings to continental power generators like Germany’s RWE and France-based Engie. The longer-term story is about overhauling an aging grid to absorb renewable-generation capacity that now provides nearly half of the European Union’s electricity, by official EU figures.
“Renewables require a completely different kind of grid,” says Luca Moro, chief investment officer at energy-focused fund SpesX, “a capillary system instead of one-way transmission from a power plant.”
Electrification of vehicles and home heating is pushing up total power demand for the first time in decades, and stock valuations remain relatively subdued. European utilities are priced at an average nine times earnings before interest, taxes, depreciation, and amortization, or Ebitda, compared with 12 times for U.S. peers, says Jens Zimmermann, the sector analyst at Gabelli Funds.
That all spells exciting times for sleepy, regulated natural monopolies that control the last kilometer to the customer. “Companies that have been cash cows for dividends suddenly have growth to offer,” Zimmermann says.
The EU estimates necessary grid investments at 584 billion euros ($679 billion) by 2030. Governments look ready to increase rates accordingly, despite already-high power prices, says Tancrede Fulop, who covers the sector for Morningstar. Utilities in the United Kingdom and Spain already have “visibility” on their rate structure into the next decade, with Germany “in negotiations,” he says.
U.S. President Donald Trump’s hostility toward Europe, plus the Strait of Hormuz closure, refocused minds on breaking fossil-fuel dependency, Zimmermann adds. “European politicians want more renewables as fast as possible again,” he says.
Investors may have to hunt a bit to find more-or-less pure plays in the grid space. The two dominant European utilities by market capitalization, Iberdrola and Enel, are integrated giants across the supply chain and geographies. The biggest names in the grid space are the U.K.’s National Grid and Germany’s E.ON, says Moro. He likes both.
Morningstar’s Fulop is also bullish on National Grid, though he sees the sector as “fairly valued” in aggregate. Zimmermann is more broadly optimistic. “There’s upside on both the earnings and valuation side, and Europe hasn’t really seen the data-center driver yet,” he says.
One yellow flag is grid operators spending beyond their means on green transformation, warns Nadege Tillier, head of corporate credit research at ING. The average capital budget has reached 130% of Ebitda, she calculates. “Their capex is far beyond the cash they make,” she says.
Bond markets are so far making up the difference, lending at close to sovereign rates. Spanish grid monopolist Redeia still got a downgrade from Fitch earlier this year, and Germany’s Amprion from Moody’s, though both remain investment-grade.
With debt mounting, rising interest rates have emerged as the sector’s top risk, Fulop adds. Financial markets are anticipating at least two hikes this year from the European Central Bank to offset the inflationary jolt spurred by the Iran war.
Stock investors tend to prefer growing pains to no growth at all, though. European utilities are starting to deliver it, and for a good reason.