Taken to the Cleaners
Revenge of the ’70s
A guide to the galaxy of low growth, high interest rates, and the dark side of the Force.
Many executives are hoping to avoid a repeat of the 1970s, when Stars Wars first hit the big screen, and when inflation, nuclear cost overruns, and diminishing returns came calling in an economic climate that today's markets threaten to emulate.
The salvation was to come from natural gas, but even that prophecy could prove wanting. Too much reliance on a single resource poses risk. Look at crude oil. In a recent research report, Morgan Stanley equity research analyst Kit Konolige notes that integrated utilities with single commodity exposure are falling out of favor. The only exceptions still in favor are companies with unregulated nuclear [nuclear capacity that is sold into unregulated wholesale markets] or companies that have locked in low coal costs and can take advantage of wholesale markets where prices are set by higher-priced gas. But even this is not a given.
There has been much discussion among industry experts about the recent decline in gas prices, driven by mild weather and bulging gas inventories. The decline has occurred in the short term; at the end, however (where utilities are bigger players), prices have fallen only slightly.
In fact, as a result, Konolige predicts that this may be the beginning of a period of out performance for regulated utilities, where regulated utility stock will trade at a premium to integrated utilities. Konolige and his team break down the prospects in this way:
- On Commodity Plays: "We continue to hear … that it's hard to expect good risk-reward characteristics for positive-gas-correlation companies with gas around the $7/MMbtu level…
- On Pure, Regulated Utilities: "The core utility investors-long-only utility funds, income funds, and close-end funds with current income requirements-are bound to find the regulated [utilities] increasingly attractive on a yield basis. …."
- On Coal Plant Owners: "Higher expenses for coal, emissions allowances, and scrubber capital spending are reasonably under control (although we believe they imply a materially lower level of earnings and significantly negative free cash flow, except in [one utility's case])."
- On Interest Rates: "We continue to think that if rates were to rise sharply, the entire group of electrics would be affected in roughly the same proportion."
What's the Right Play?
With all this evidence indicating a large tectonic shift in earnings prospects for utilities, the challenge becomes how to stay on top of the revenue list.
In an exclusive interview at Accenture's 16th annual International Utilities and Energy Conference (IUEC), Omar Abbosh, Accenture's global managing partner for the utilities industry, outlined some of the issues and tough decisions facing senior executives regarding people, policy, and growth.
"My fundamental premise," he says, "is that growth is there to those who understand how to access it."
Yet Abbosh doesn't necessarily believe that maintaining a "high-performance company," in Accenture parlance, will require holding companies to jettison the regulated utility.
"What [investors] are looking for is real cash-flow growth."
When it comes to being at the high-end of the universe in terms of growth, Abbosh