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Utility Valuation: Shedding Light on the Black Box

Experts debate how energy companies should be valued in the wake of electric restructuring and Enron.
Fortnightly Magazine - April 15 2002

analyst (CFA) and analyst with UBS Global Asset Management, sees different aspects to a possible interest rate jump. "One, the discount rate would increase as the cost of capital increases. Corresponding with an interest rate increase would be a general pickup in the economy, so perhaps there would be greater revenue growth or economic activity associated as well. Perhaps they would be offsetting. But for specific companies, there might be some netting one way or the other," he explains.

The Earnings Schizophrenia: Regulated and Unregulated, Same P/E?

Jeff Bodington, president of Bodington & Company, a financial and consulting boutique, believes that the financial markets are at a loss for how to analyze and evaluate energy companies in the electric restructuring era, especially after Enron. "I think that many analysts are getting it wrong and focusing too much on the downside risk and being overly conservative. They are damaging valuations as a result of things like Enron," he says.

Because the differences between most diversified utility companies and Enron have not been widely appreciated, "the stock values of these other companies have been hammered. ... If you look at what has happened to those stocks since Enron's announcement, they have gone down, down, down. Whereas, there is really no new information," he says.

In fact, many so-called growth companies found their P/E ratios in January and February 2002 below even those of traditionally vertically integrated utilities. For example, Calpine's P/E has been under four, AES has been under six, and Reliant's has been under eight.

Bodington attributed the stock drop to nervousness about companies that have been associated with Enron. The result of this nervous reaction by Wall Street and investors is to increase the debt/equity ratios of these companies as the market value of the equity in the company falls and the debt in proportion to total capital rises, he says.

"As a result, the lenders which for years have financed the asset-heavies' expansion programs, are not only saying we won't lend you anymore, but we think you should sell assets and use the cash to pay down some of the debt to bring your debt/equity ratio back into comfortable relationships," says Bodington.

Mark Ciolek, a partner in PwC Consulting's energy industry practice, a business arm of PricewaterhouseCoopers, is also puzzled by the lack of distinction between very different businesses in the energy industry. If you look at a wires model, a merchant generation company, or a vertically integrated utility, the P/E ratios, in the early part of the year, were all relatively the same, he says.

"Of course, I think that whole market sector has really been unfairly punished, and maybe it is the flip side of being overly valued for the last two years that now they are seeing the crunch from Wall Street. On the other hand, some of the turn downs in valuations for some of the pure IPPs like Calpine and NRG and Mirant probably reflect the fact that they have been over-leveraged and people have been paying too much to get assets in the generation sector.