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Turning Capital to Wealth: A Ranking of U. S. Utilities

Fortnightly Magazine - December 1999

Hills, Montana Power and IPALCO are focused regionally. Con Edison and Montana Power are exiting the generation business altogether. There are no clear winners in any dimension of competition - local vs. global focus, full value chain vs. niche participation, or single energy source vs. gas-electric combinations.

Perhaps this outcome should be expected in an industry in flux. New business models are still being developed and tested. Some firms are buying what others are selling as both groups attempt to specialize and establish core competencies. During the next three to five years, winners surely will be more widely separated from the pack, and dominant strategies and success factors will emerge.

It is very interesting that 14 of the top 15 MVA-creating companies are nuclear utilities. Of those 14, Duke, CP&L, Con Ed and FP&L also do well in the standardized MVA rankings. These utilities have an aging, well-depreciated nuclear fleet whose book value may understate the true value of capital invested, thus leading to large EVA and MVA (or market valuation). The significant MVA accorded by the market to these utilities also may reflect a belief that the government will bail out the large nuclear decommissioning liabilities of these firms.

Practical Considerations:


Is MVA a reliable and useful measure of performance? How well does MVA correlate with other traditional performance measures, such as earnings per share or return on equity?

Figure 2 shows the correlation between standardized MVA and various performance measures. The correlation between standardized EVA and MVA is superior to the correlation between standardized MVA and EPS, net income, return on assets (ROA), return on equity (ROE) and free cash flow. Free cash flow and EPS have little correlation with MVA. EPS completely ignores balance sheet efficiency, and free cash flow doesn't allow differentiation between poor operations and high investment. ROA and ROE have a higher correlation, as they attempt to link operating efficiency (net income) with capital efficiency (assets or equity). Net income also has a higher correlation with MVA than is observed for non-regulated industries because revenues in the utility industry are adjusted to guarantee a return on equity. It must be noted that the EVA measure used here is generic. In our experience, a tailored EVA measure, such as we develop in an EVA implementation, has a still higher correlation with MVA.

Nevertheless, the MVA method does have shortcomings that might discourage its use as a day-to-day performance measure. For instance, MVA fluctuates by the minute as stock prices fluctuate. The fluctuations may or may not be related to the firm's operating performance. MVA is observable only for the consolidated firm as a whole, and not for individual business units. Finally, firms that are not publicly traded will not have an observable MVA.

Our firm's EVA method can help overcome objections that MVA is impractical for use in benchmarking.

EVA is defined simply as annual operating profit less a charge for the use of all capital - debt and equity.

EVA = Operating profit - capital charge = Operating profit - [(cost of capital)