A defense of the total return to shareholders (TRS). Our authors use TRS as the bottom-line performance indicator, and come up with a number of performance insights.
The Top Utility Stocks
A review of total shareholder returns shows how growth and merger strategies drove performance last year.
- FirstEnergy operate within the context of their back-to-basics strategies.
Even so, among companies that recorded double-digit TSRs in 2005, most of them either recorded strong performance from growth or merger strategies or they posted gains linked to ongoing recovery efforts. Traditionalists that were among the 2005 leaders typically counted on returns in the form of strong dividends (see Figure 1).
However, it appears that most of the top 10 companies are pursuing growth strategies. Both TXU and NRG, for example, were recovering utilities a few years ago. In the case of TXU, new leadership has cut costs, repaired the balance sheet, and transitioned to an aggressive growth strategy premised on operational excellence and the implementation of a high-performance operating model. NRG is using a restructured balance sheet to aggressively purchase additional power-plant assets. Constellation Energy (CEG) is pursuing a national growth strategy across all parts of the energy value chain. MDU Resources is pursuing growth through a more classic diversification strategy complemented by power-plant acquisitions.
Perhaps even more interesting, traditionalist utilities dominated the list of companies that had negative or very modest TSR performance in 2005 (see Figure 2) . Heavily regulated electric utilities with limited wholesale businesses ( e.g., UIL Holdings, DQE, Energy East, and Puget Energy) were vulnerable to higher wholesale prices or could not enjoy the earnings associated with those higher prices. Rising gas prices and the market’s fear of a related increase in conservation and bad debt expenses negatively affected utilities with significant downstream (and limited upstream) gas businesses, such as Keyspan and NiSource. Other utilities, such as PNW, recorded lower earnings due to unfavorable regulatory decisions.
Overall, in 2005, the 58 utilities in our data set added almost $75 billion in market value. Most of that value came from companies in the growth and merger strategy groups. In particular, Exelon, TXU, and Dominion combined contributed about 25 percent of the total value created, mainly because of their size and significant market gains. Companies such as PSEG, while smaller, got a boost from merger announcements.
In examining TSR for 2005, when weighted by market capitalization, returns for the utilities in the traditionalist group significantly underperformed relative to all the other strategy groups (see Figure 3). This illustrates the premium that the market placed on companies with solid but aggressive growth strategies—as opposed to companies with solid but conservatively positioned strategies centered on their core regulated markets. This marks a change from the market’s view two years ago, when it rewarded companies with solidly regulated businesses. In particular, wires companies such as Energy East, Northeast Utilities, and DQE did much better in 2003 than in 2005. Even integrated electrics like Southern Co. and Pinnacle West (Arizona Public Service), which are back-to-basics companies, returned only 3.1 percent and -2.5 percent, respectively, in 2005, compared with 11.6 percent and 22.4 percent, respectively, in 2003.
But as noted earlier, utilities, especially traditionalists, often are not focused simply on single-year returns. What about returns over the longer term?
Buy and Hold vs. Buy Low and Sell High
In the 2001-2005 period, our