Analysts: Down on utilities. Is the party over? That’s the tough question posed in a research note by Wachovia equity research analyst Samuel Brothwell.
The Top Utility Stocks
A review of total shareholder returns shows how growth and merger strategies drove performance last year.
set of 58 companies created $133.3 billion in shareholder value in connection with an overall (weighted) 39 percent return over the five-year period (see Figure 4).
But the return trajectory was not a smooth upward glide through the period. Immediately following the collapse of Enron, all utility stocks fell out of favor, followed by a rebound beginning in 2003. Over the three-year period, 2003-2005, the set of 58 companies created $212.5 billion in shareholder value in connection with an overall 80 percent return.
Led by the explosive recovery of companies such as TXU, AES, Allegheny Energy, and Dynegy, a company had to have 90 percent returns over the three-year period to make it to the top quartile of this ranking. Only eight utilities had returns of less than 20 percent over the 2003-2005 period. Most investors that carefully moved into utility stocks when the industry settled down and entered the back-to-basics period did very well.
However, with the hit that all utilities took in 2001-2002, investors that had a long-term “hold” strategy for their utility investments saw lower returns over that longer 2001-2005 period. Clearly, investors would have been better off had they—as many did—sold utilities as soon as events unfolded following the collapse of Enron and then rebought utility stocks once they bottomed out.
Surprisingly, even from the perspective of a long-term investment strategy for the past five years, investors would have seen great returns by investing in growth companies, as well as seen very respectable returns in investments in companies in both the traditionalist and merger groups.
But most likely, investors would have seen losses associated with their investments in companies in the recovering group. Companies such as Dynegy, Aquila, AES, CMS Energy, and Allegheny Energy, when viewed from a long-term perspective, did recover, but not enough to overcome the hit they took when Enron collapsed.
Higher Risk, Higher Returns
Perhaps utilities as potential investments never were a homogenous group. However, entering the period of the late 1990s, we saw utility companies pursue one of two strategic paths: Some went after aggressive earnings growth through investments in wholesale energy marketing, international operations, or merchant power plants, while others stayed closer to their utility roots.
Today, we can see winners (growth) and losers (recovering) comprising a single strategy group that pursued earnings growth beyond what the typical utility business provides.
Our so-called growth group includes companies such as Sempra, PPL, and MDU Resources. These companies continue to make bets in competitive businesses and are succeeding in delivering income and returns from these investments. The growth group also includes companies, such as TXU and NRG, that have recovered from the crisis period of 2001-2002 and now are executing aggressive earnings and acquisition strategies.
The recovering group includes companies such as Reliant, Teco Energy, and Allegheny Energy, which made similar bets to deliver aggressive earnings growth and have thus far failed to deliver. Either the margins and earnings weren’t forthcoming, the companies overpaid for assets, they took on too much balance-sheet and credit risk—or all three!
From a TSR perspective, investors that made