Utilities are hot right now and Morgan Stanley sees further upside. Here are its top global picks

Published Thu, May 5 20227:57 AM EDTUpdated Thu, May 5 20228:04 AM EDT

Utilities have enjoyed a strong start to the year and Morgan Stanley thinks there's more upside to come, naming its favorite global stocks in the sector. Utility stocks have long been considered a safe haven in times of market upheaval. The sector tends to be less volatile, given its steady and regulated earnings profile, inflation-based contract clauses and higher dividend income relative to other sectors. It has also been an outperformer in an otherwise volatile market this year. It was one of just two sectors on the S & P 500 that delivered positive returns in the first quarter — the other was energy — ending the period up 4.8%. It was also the least volatile sector and enjoyed the second-highest dividend yield relative to other sectors on the index, according to Goldman Sachs. Now, Morgan Stanley's analysts think there could be more outperformance ahead. "We see a compelling argument for utilities to outperform the market given the confluence of policy and macro developments. The sector combines defensive qualities, green growth, [earnings per share] upgrades from higher power prices; and reinforced policy tailwinds from energy security and climate considerations," Morgan Stanley's analysts, led by Robert Pulleyn, said on May. 3. "We believe all the key components of power markets – tightening supply/ demand… persistently higher gas prices, structurally higher carbon prices and energy policy – imply a stronger for longer outlook," he added. The bank noted that power prices in Europe have risen between 150% to 300% over the past 12 months, outpacing other commodity price moves apart from gas. It expects power prices to continue to remain "elevated" for the next five years. Stock picks Morgan Stanley's top pick in the utility sector is Denmark's energy firm Orsted — the world's largest developer of offshore wind power. The bank expects Orsted to retain its leadership in the sector in terms of market share, absolute growth, and market perception. The bank added that while clean energy stocks have underperformed this year, it expects the sector to "come back into vogue" given the future growth potential in decarbonization and renewables. Read more Stay defensive with these global stocks amid market volatility, analysts say It noted that a "record year" of offshore wind project awards in 2022 provides a near-term catalyst, while a combination of strong compounded earnings growth and contractually-secured earnings creates a "uniquely attractive combination" for the stock. The bank has increased its price target to 1,000 Danish krone on the stock, which closed at 750 Danish Krone on May. 4, representing a potential upside of 25%. Outside of pure-plays, Morgan Stanley believes German-based energy firm RWE is most leveraged to higher power prices. The bank's forecasts for the company's earnings in 2022 and 2023 are 25% and 44% ahead of the average forecast of all analysts covering the stock. The bank expects the stock to perform with EPS upgrades through power exposure and the likely acceleration of green investments from the new European energy policy outlook. It also expects the company to benefit from rising commodity prices in the short-term as well as the longer-term transition to a clean growth story. The bank has increased its price target on the stock to 50 euros, implying a potential upside of 22% to its closing price of 41 euros on May. 4.

High-voltage power lines at sunset.

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Utilities have enjoyed a strong start to the year and Morgan Stanley thinks there's more upside to come, naming its favorite global stocks in the sector.