Utility Sector Yield Comparisons
Utility stocks attract investors for one reason: yield. The sector consistently offers 3-5% dividend yields compared to the S&P 500's 1.5%. But utilities are not bonds - they're equities with earnings growth, regulatory risk, and significant interest rate sensitivity. Understanding regulated economics, rate base growth, and the yield spread to Treasuries separates informed utility investors from those who treat the sector as a bond substitute and get burned when rates rise.
The Regulated Utility Model (Why Utilities Are Different)
Most utilities operate under regulatory compacts: they provide essential services (electricity, gas, water) as monopolies in exchange for regulated returns. State public utility commissions (PUCs) set rates that allow utilities to earn a specified return on their invested capital.
The regulated earnings formula: Allowed Revenue = Operating Costs + Depreciation + (Rate Base × Allowed ROE)
Key components:
- Rate Base: The value of utility assets (plants, transmission lines, infrastructure) on which the company earns a return
- Allowed ROE: The return on equity permitted by regulators (typically 9-11%)
Worked example - Duke Energy:
- Rate base: $90 billion
- Allowed ROE: 10.0%
- Equity ratio: 52%
- Allowed equity return: $90B × 52% × 10.0% = $4.68 billion
The practical point: Utility earnings are predictable because regulators guarantee a return on invested capital. Growth comes from expanding the rate base through infrastructure investment, not from gaining market share or raising prices aggressively.
Rate Base Growth (The Utility Growth Engine)
Rate base CAGR drives earnings growth:
| Rate Base Growth | Typical EPS Growth | Dividend Growth |
|---|---|---|
| 6-8% | 5-7% | 5-6% |
| 4-6% | 4-5% | 3-5% |
| 2-4% | 2-4% | 2-3% |
Why rate base grows:
- Grid modernization (replacing aging infrastructure)
- Renewable generation (solar, wind, battery storage)
- Transmission expansion (connecting new resources)
- Electric vehicle infrastructure
- Electrification of heating/industrial processes
Investment trajectory (2024-2030 estimates):
| Utility | Capex Plan | Rate Base CAGR |
|---|---|---|
| NextEra Energy | $85-95 billion | 9-10% |
| Duke Energy | $73 billion | 7-8% |
| Southern Company | $48 billion | 6-7% |
| Dominion Energy | $43 billion | 5-6% |
The durable lesson: Not all utilities grow equally. A utility with 8% rate base growth compounds value far faster than one growing at 3%. The price you pay should reflect this growth differential.
Allowed ROE (The Regulatory Constraint)
State regulators set allowed returns through rate cases, which are adversarial proceedings where utilities request returns and intervenors (consumer advocates, industrial users) argue for lower rates.
Current allowed ROE ranges (2024):
| State/Region | Allowed ROE Range |
|---|---|
| Texas | 9.4-10.0% |
| Florida | 9.5-10.5% |
| California | 9.0-9.5% |
| New York | 8.8-9.2% |
| Regional average | 9.5% |
Trend: Allowed ROEs have declined from 10.5-11.5% a decade ago to 9.0-10.0% currently, tracking the decline in Treasury yields.
ROE sensitivity to Treasury rates: Historically, allowed ROEs move with the 30-year Treasury but with a lag of 12-24 months and dampened magnitude (regulators don't adjust 1-for-1 with rates).
Example - Rising rate environment (2022-2024):
- 30-year Treasury: Increased from 2.0% to 4.5% (+250 bps)
- Allowed ROEs: Increased from 9.2% to 9.8% (+60 bps)
- Pass-through ratio: ~25%
Why this matters: When interest rates rise, utilities can eventually earn higher allowed ROEs - but the lag and incomplete pass-through means utility valuations typically fall before earnings catch up.
Regulated vs. Merchant Utilities (A Critical Distinction)
Regulated utilities:
- Revenue guaranteed by rate compact
- Earnings predictable (5-7% growth typical)
- Lower risk, lower volatility
- Trade at premium valuations
Merchant/competitive power:
- Sell power into wholesale markets at fluctuating prices
- Earnings volatile (tied to power prices, fuel spreads)
- Higher risk, higher potential return
- Trade at discounted valuations
Mixed companies: Many utilities have both regulated and merchant segments.
| Company | % Regulated | % Merchant/Other |
|---|---|---|
| Duke Energy | 95%+ | <5% |
| Southern Company | 90%+ | <10% |
| NRG Energy | 0% | 100% (pure merchant) |
| Vistra Energy | 0% | 100% (pure merchant) |
| NextEra Energy | 70% | 30% (renewables) |
The practical point: If you want bond-like stability, focus on >80% regulated utilities. If you want commodity exposure (power prices, gas spreads), merchant generators offer leverage to those inputs.
Dividend Yield Analysis (The Core Comparison)
Yield Spread to 10-Year Treasury
Utility yields are best evaluated relative to Treasury yields, not in absolute terms.
Historical spread (utility dividend yield minus 10-year Treasury):
| Environment | Typical Spread |
|---|---|
| Normal | +150 to +200 bps |
| Utilities expensive | +50 to +100 bps |
| Utilities cheap | +250 to +350 bps |
Example - December 2024:
- Utility sector yield (XLU): 3.1%
- 10-year Treasury: 4.5%
- Spread: -140 bps (negative - utilities yield less than Treasuries)
Interpretation: When utilities yield less than Treasuries, you're paying for equity risk without adequate compensation. Historically, this signals utility sector overvaluation.
Historical pattern:
- 2007: Spread narrowed to +50 bps → Utilities underperformed next 12 months
- 2018: Spread compressed → Utilities underperformed as rates rose
- 2020: Spread widened to +300 bps → Utilities outperformed significantly
Current Yield Comparison (December 2024)
| Utility | Dividend Yield | Payout Ratio | 5-Year Div CAGR |
|---|---|---|---|
| Duke Energy | 4.2% | 73% | 2.1% |
| Southern Company | 3.8% | 77% | 3.2% |
| NextEra Energy | 2.8% | 60% | 10.1% |
| Dominion Energy | 5.1% | 88% | -2.4% (cut) |
| Xcel Energy | 3.4% | 62% | 5.8% |
The test: A 5%+ yield in utilities often signals market concern about dividend sustainability (see Dominion's 2020 cut). High yields require extra scrutiny, not celebration.
Interest Rate Sensitivity (The Duration Problem)
Utilities behave like long-duration assets because their stable cash flows are valued similarly to bonds.
Sector sensitivity to rate changes:
| Rate Move | Typical Utility Response |
|---|---|
| +100 bps in 10-year | -8% to -12% sector return |
| -100 bps in 10-year | +8% to +12% sector return |
| Flat rates | Normal earnings-driven returns |
Why utilities are rate-sensitive:
- Valuation effect: Dividend discount models use higher rates, reducing fair value
- Relative attractiveness: Treasuries compete for income investors
- Financing costs: Utilities are capital-intensive with significant debt
Historical example - 2022:
- 10-year Treasury: Rose from 1.5% to 3.9% (+240 bps)
- XLU total return: +1.5% (vs. S&P 500 -18%)
- Utilities outperformed despite rate pressure due to defensive rotation
The nuance: In recessions, utilities can outperform even with rising rates because their defensive characteristics dominate. In "soft landing" scenarios where rates rise without recession, utilities typically struggle.
Utility Sector Analysis Checklist
Essential (High ROI)
Core valuation framework:
- Calculate yield spread to 10-year Treasury (>150 bps is attractive)
- Check payout ratio (below 75% provides dividend safety)
- Assess regulated vs. merchant mix (prefer >80% regulated for stability)
- Review rate base growth trajectory (5%+ supports dividend growth)
High-Impact (Deeper Analysis)
For concentrated positions:
- Track pending rate cases (allowed ROE outcomes)
- Review capital investment plans (3-5 year outlook)
- Assess regulatory jurisdiction quality (constructive vs. adversarial)
- Monitor interest rate sensitivity in your overall portfolio
Optional (Advanced)
For sector specialists:
- Model earnings sensitivity to rate case outcomes
- Analyze renewable energy transition capex and rate recovery
- Evaluate wildfire/climate liability exposure (California utilities)
- Track capacity market pricing (merchant generators)
Worked Example: Evaluating a Utility Stock
Southern Company analysis:
Step 1 - Yield comparison:
- Current dividend: $2.88/share
- Current price: $76
- Yield: 3.8%
- 10-year Treasury: 4.5%
- Spread: -70 bps (below historical average)
Step 2 - Growth assessment:
- Rate base: $75 billion
- Planned capex (2024-2028): $48 billion
- Expected rate base CAGR: 6-7%
- Expected EPS growth: 5-6%
Step 3 - Safety check:
- Payout ratio: 77% (manageable)
- Credit rating: A/A2 (investment grade)
- % Regulated: ~95% (low merchant risk)
Step 4 - Valuation:
- P/E: 19x forward earnings
- Historical P/E range: 16-22x
- Assessment: Mid-range valuation
Conclusion: Southern offers solid regulated fundamentals but the negative yield spread suggests waiting for either a price pullback or Treasury yield decline before adding.
Next Step (Put This Into Practice)
Calculate the yield spread for the utility sector and compare to your income alternatives.
How to do it:
- Find XLU dividend yield (Yahoo Finance or ETF provider website)
- Find 10-year Treasury yield (Treasury.gov or financial news)
- Subtract: Utility Yield - Treasury Yield = Spread
- Compare to historical average (+150 to +200 bps)
Interpretation:
- Spread > +200 bps: Utilities potentially attractive
- Spread +100 to +200 bps: Fair value range
- Spread < +100 bps: Utilities potentially overvalued
Action: If the spread is below +100 bps and you hold utilities primarily for income, consider reallocating a portion to investment-grade corporate bonds or Treasury notes - you're taking equity risk without adequate yield compensation.