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.
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disconnect between the DuPont rankings and TRS performance. Does strong performance against the DuPont translate into shareholder results? What about positive market expectations? Fig. 1 shows TRS performance measured against the DuPont Index. TRS is not correlated with the DuPont Index (R 2=0.0342). One explanation is that the DuPont is a decidedly historical measure and does not take into account future indicative trends. It is a trailing index, tailored for mature capital intensive industries and does not reward growth or pick up market expectations.
Taking TRS as the bottom-line performance indicator, a number of performance insights emerge:
• There is a strong correlation between TRS and ROIC-WACC.
Consistent with other capital-intensive industries, capital efficiency, as reflected in the ROIC spread, is the most predictive factor for overall shareholder performance (see Figure 2) . Historically, the regulatory compact covered a multitude of capital spending sins. However, increasing deregulation, coupled with elongated regulatory cycles, tougher regulatory review in many jurisdictions, and escalating capital demands, is making capital allocation and management increasingly predictive. Unlike many operational measures that are driven by demand and jurisdictional characteristics, capital management has a large discretionary component and is highly controllable by management over the long term.
• There is little correlation between operational performance and TRS.
Operational leadership is not highly predictive of overall shareholder return in the utilities industry. For example, operational performance, measured by operating margin, has a low correlation with TRS or ROIC-WACC (R 2=0.076 and 0.30, respectively). The regulatory compact historically has not rewarded top decile operational efficiency. High performers typically are not the most efficient operators, but rather, they are good, typically second- quartile performers that manage the service and regulatory sides of the performance equation. The exception is generation, where cost leadership is highly advantaged for like fleets, assuming similar availability factors. Translating operating performance to bottom-line shareholder value is highly dependent on being in a favorable regulatory jurisdiction. Gain-sharing regulatory mechanisms and increasing exposure to unregulated competition will increase the importance of operational performance.
• Growth expectations are driving TRS. Yield is inversely correlated to implied growth.
Utilities stocks have an embedded average implied annual growth rate of more than 6 percent—with a wide range from just over zero to more than 13 percent. These are aggressive figures for an industry with approximately 2 percent intrinsic growth. It is driven largely by the market’s confidence in a company’s strategy, value propo- sition, and associated capabilities, and it is influenced by management. ROIC spread is a good interpretative factor of a company’s ability to realize growth expectations. It is an indicator of how well management’s portfolio priorities and investments are bearing fruit. In general, higher-yield companies have lower implied growth expectations.
In other words, new value-chain models, good portfolio management, and superior capital efficiency are being recognized by the market and translated into growth expectations to the extent that strategy and positive ROIC trends suggest future earnings growth. Adjusting for interest rates, and “rebound” stocks such as AES, TRS performance in the industry is being driven largely by these growth expectations.