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Winners and Losers: Utility Strategy and Shareholder Return

Diversified companies lead (and the globals lag) over the past five years.

Fortnightly Magazine - October 2004

percent, compared with the 4.7 percent group median. Table 2 also shows that many companies with proved oil and gas reserves were among the top performers in 2003, averaging a 6.7 percent five-year average annual return (8.7 percent if The Williams Cos. and El Paso Corp. are removed).

Overseas Trouble

Companies with substantial foreign investments continue to be plagued by those choices. Of the top six companies in terms of revenues from international operations, four have been bottom quartile, providing negative shareholder returns. Responding to these challenges, many companies have reduced their international exposure over the past year. Some recent international withdrawals include TXU Corp.'s exit from its retail electric and gas businesses in the UK and Australia, El Paso's withdrawal from its Czech generation business, and Duke's sale of its Asia-Pacific assets. Nevertheless, PPL Corp. and Sempra continue to perform well even with their international investments, perhaps owing in part to each company's solid base of domestic regulated utility operations. Table 3 (p. 32) shows some reduction in international exposure but belies the fact that most of the recent sales of international operations are still included as discontinued operations in the 2003 financial statements.

Lightening the Debt Load: The South Beach Balance Sheet

This past year was one of de-leveraging for U.S. energy companies, following the debt binge that accompanied diversification and expansion in the 1999-2002 period. Figure 3 illustrates the total cycle.

Last year, we saw a strong correlation between overleveraging and negative five-year shareholder returns. That correlation holds for this year as well, as shown in Table 4.

However, we note the significant progress made by Allegheny Energy Inc., AES Corp., Centerpoint Energy Inc., and Edison International to improve their balance sheets over the past year. Most of this progress was accomplished through asset sales, with Allegheny selling generation and other non-regulated businesses, and AES raising over $700 million through the sale of CILCORP and several international generating facilities, for example.

Efficient Use of Capital

Return on Invested Capital (ROIC) continues to be an excellent indicator of a company's ability to provide sustained long-term returns to shareholders. ROIC is a more stable measure of financial performance than shareholder returns since it depends on earnings and not on volatile stock prices. Table 5 () shows that the consistent ROIC performers primarily have been the natural-gas-oriented companies. This may be attributed to three factors: the avoidance of the troubled merchant investments of their electric peers, the relative stability of their regulated gas distribution businesses, and the upside from investments in upstream natural gas operations.

FPL Group is the only company without substantial natural-gas operations to make the list of companies returning top-tier ROIC. FPL has benefited from the state of Florida's consistent stance of not deregulating its electric markets, which perhaps, combined with a performance-based rate plan put in place in 2002, has provided returns at a premium to peers. Also, FPL's merchant energy strategy has been relatively conservative, representing less than 10 percent of 2003 total revenue.

The utility sector, once characterized by a homogeneous group of vertically integrated companies,