Should the power industry adapt its approach to capital markets in this environment? The answer, of course, is yes. Multiple frameworks are necessary to establish a power company’s or project’s...
Winners and Losers: Utility Strategy and Shareholder Return
Diversified companies lead (and the globals lag) over the past five years.
year's winners in those categories are Western Gas Resources (5-Year: 53.7 percent), UGI Corp. (3-Year: 32.4 percent) and The Williams Cos. (1-Year: 265.7 percent). Exelon fell off the top of the leader's list primarily because its five-year performance no longer includes 1998-a stellar year for its shareholders-when the company successfully positioned itself for deregulation. The Williams Companies took over from UGI Corp. as the leader in the one-year return category because of Williams' meteoric recovery from near disaster in 2002.
Business Risk and the Efficient Frontier
Portfolio management theory dictates that greater risks should yield greater returns. The portfolio combinations of risks and returns that optimize these trade-offs are on the "efficient frontier." The same analysis can be applied to corporate business models. Figure 2 illustrates the risk and reward profiles represented by the universe of 66 companies in our study. The chart compares average shareholder returns for the group against the volatility (or risk) of those returns. Moving from left to right on the chart implies greater risk and, therefore, the expectation of higher earnings. In fact, however, many of the higher risk companies have provided significantly lower returns.
The overall shareholder return winner for the period, Western Resources, achieved a 54 percent average annual return with a 16 percent level of risk (standard deviation in monthly shareholder return). Calpine returned 9 percent to its shareholders over this period, but that was coupled with a 28 percent risk quotient. Moving to lower levels of risk, an investor could have achieved 10 percent to 23 percent average returns at 7 percent to 10 percent levels of risk with the group of companies centered in the northwest quadrant.
Of these, an investor might prefer UGI's 23 percent return and 7.4 percent risk, or New Jersey Resources' 12 percent return and only 4.3 percent risk. Companies with lower returns or higher risks are simply less attractive-unless, of course, their business prospects are not reflected by their past performance.
Diversified Business Models Are Working
The group of companies that delivered top-quartile five-year annualized shareholder returns is dominated by diversified energy companies. Last year's report highlighted the enduring contributions from regulated returns. This year, only five of the 17 top-quartile companies derived more than 75 percent of their revenue from regulated operations (Entergy Corp., Southern Co., PNM Resources Inc., Keyspan Corp., and Piedmont Natural Gas Co.). Diversification is paying off, or at least it is not overwhelming solid results from regulated operations.
Natural Gas Value Chain Boosts Returns
This year, companies with significant natural gas operations were clear leaders in the 5-year average annual return category. This group includes companies with natural gas exploration and production, and distribution businesses. Clearly, those companies with upstream investments have benefited from the sustained increases in natural gas prices. Western Gas Resources, a company with operations concentrated in natural gas exploration and production, led the five-year shareholder return category with a 53.7 percent annualized performance, as shown in Table 2. Overall, companies deriving 50 percent or more of their revenue from natural gas operations earned a median return of 5.9