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Wall Street's Egalitarian View
the best way to gauge changes in investor sentiment, particularly because the use of estimated earnings when calculating the latest P/E ratios sometimes can have the consequence of making the multiples converge. Hyman says if he were doing the analysis, he would look to other indicators to substantiate P/E multiples convergence. “I would look at returns earned or potential returns, and I also would look at the book value. If you look at integrated utilities and the LDCs, those companies will earn a flow of income determined by the investment that has been made.
Hyman says: “I would look at how the market-to-book moves back and forth over time and do that to some extent in relation to interest rates. I would also look at what is going on with dividend yields if you take the view that the dividend is a proxy for what is going on with dividend yields.” Coben did not return calls for comment by press time.
Moreover, Hyman emphasizes, the question of whether the chart shows convergence, and the issue of whether investors truly understand the risks of their investments, are quite different. “It’s certainly a legitimate question. What are people paying for now?” he says.
For example, Hyman argues that at least in the T&D space, investors may not be fully taking into account the risks that exist given some of the provider of last resort obligations that these wires companies are taking on in some states.
Meanwhile, Coben notes that although utilities have been performing well, the S&P 500 has come down substantially and the value proposition represented by the industry compared with other broader industrials may not be as compelling. In fact, she says, consolidation trends, higher commodity prices, and rate pressures will make it much more difficult for utilities to stand out from their peers.
“The industry is in a position where there are some great opportunities, but probably more risks than we have seen in the past,” she adds.
Mixing It Up
If investors are forming an egalitarian view of the industry, it’s probably because many utilities are a mix of different business strategies. In fact, many arguments have broken out over the years over how to categorize some utilities that have everything from unregulated merchant arms, regulated utilities, pipelines, and exploration and production, all under one roof.
As utilities consolidate, albeit slowly, the larger companies that emerge will have a much more difficult time standing out in terms of earnings growth due to size.
Furthermore, size in some ways will dictate the strategy options open to utilities.
For example, the 10 largest companies now are expected to be 56 percent of the total versus 32 percent in 1995, Coben says. “To be a top 15 utility in 1996, all you needed was a $5 billion market capitalization. Today that number is double,” she says. So too has the size and scale gone up in the generation and customer ranking areas.
Ten years ago, 10,000 MW of generation would have been considered large and, the utility thought, competitive. “Today, that number is