A spate of newly announced deals, including Allegheny Energy’s proposed $9.27 billion acquisition of FirstEnergy, plus PPL’s takeover of E.ON US for $6.73 billion, has left the utility industry...
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- provided by Public Utilities Report's Regulatory Research Service.
- See, "Utilities' Loans Are Offers They Can't Refuse," The Wall Street Journal, Dec. 27, 2002.
- The actual figure was generated using a Monte-Carlo model.
- The mathematics of the DCF tends to drive a utility's stock price to its book value, since, as a utility's stock price increases above book value, the dividend yield falls. This lowers the calculated cost of equity and, if translated directly to the utility's allowed return, will reduce earnings and, therefore, the utility's stock price. For a utility trading below book, the opposite effect occurs, driving the stock price up.
- One proposed solution has been to use a non-constant growth model during a "transition" period, and then a long-term growth rate. This raises two problems: How is the transition period defined, and how are growth rates during this transition period determined?
- Capital market efficiency and ratepayer equity may be at odds for different utilities that operate under a single holding company. Efficiency dictates that the cost of equity for the individual subsidiaries should be the same, since investors see the risk of the holding company, not the individual subsidiaries. Ratepayer equity, however, may lead regulators to impose different allowed returns on the subsidiaries, so that (say) gas company ratepayers are not also paying for electric market volatility, and vice versa.
- A thorough discussion of the evolution of the DCF can be found in Win Whitaker, "The Discounted Cash Flow Methodology: Its Use in Estimating a Utility's Cost of Capital," Energy Law Journal 12 (1991), pp. 265-290.
- The theory underlying the DCF holds for any stock, not just a utility. However, historically the use of the DCF to estimate utilities' cost of equity was ideally suited because utilities paid steady dividends.
- The derivation of this formula can be found in many financial textbooks.
- For one approach to the diversification problem (written prior to electric industry restructuring and retail competition), see Jeff Mackholm and Donald Sanfer, "Calculating Fairness," Public Utilities Fortnightly, Nov. 15, 1993, pp. 41-45.
- Typically, proxy group companies include those followed by the Value Line Investment Survey. In 1998, Value Line followed 27 natural gas distribution companies. Today, that number is lower by one-third, to only 18 companies.
Business News Bytes
PPL Beats Fourth-Quarter Estimates
PPL posted $116 million in net income, or 71 cents a share, compared with a loss of $312 million, or $2.13 a share, a year earlier. Revenue rose to $1.3 billion from $1.2 billion. Core earnings, which exclude one-time items, reached 82 cents a share, compared to the average 70-cent estimate of analysts polled by Thomson First Call and the year-ago profit of 87 cents. The company said it benefited from improved revenue from international operations and increased electricity deliveries. Looking ahead, PPL lowered its 2003 core earnings-per-share forecast to $3.45 to $3.75 from $3.60 to $3.80. The updated forecast, which reflects its plan to issue about $300 million in common stock this year, is still within analysts' $3.66 target. CEO William Hecht reaffirmed that annual earnings growth from core operations would likely rise 5