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The Top Utility Stocks: New Challenges Ahead

Utilities showed strong gains last year, but other industries are gaining ground.

Fortnightly Magazine - March 2007

electric and gas energy delivery assets and customers. Some of the companies in this group are aggressively pursuing non-regulated growth strategies ( e.g., Constellation Energy), while others are pure regulated utilities ( e.g., Western Resources).

The 2006 Performance Story

Most utilities recorded double-digit TSRs in 2006. To make the top quartile, a company had to show almost 30 percent returns.

For 2006, top-10 utilities showed single-year returns of 38 percent or better (see Figure 3) . Companies in each group were represented, but it is worth noting that three of the four companies in the Power Generation group were in the top 10.

In the list of companies that had negative or modest TSR performance in 2006, several in merger situations stood out, specifically PSEG with its failed merger with Exelon, and WPS with its announced merger with Peoples Energy (see Figure 4) .

In 2006, the utilities in our data set added almost $105 billion in overall market value. While most of that value came from the largest group (Integrated Electric and Gas), the group with the highest percentage growth in market capitalization was the Power Generation group, Dynegy increasing 86 percent, NRG 86 percent, and AES 42 percent in overall value for 2006 (see Figure 5) .

Accordingly, in examining TSR for 2006, when weighted by market capitalization, returns for the utilities in the Power Generation group significantly outperformed all the other strategy groups. The Integrated Gas group also did well. Traditional utility groups (Integrated Electric and Gas, Energy Delivery, and Gas Utilities) showed returns that were similar and below those of the other two groups.

Longer-Term Performance Leadership

The top performing group over the past three years was dominated by companies that had rebounded from poor investments, energy marketing debacles, or investor disdain for Enron-clones (TXU, Williams, Allegheny Energy, AES, Edison International, CMS, Reliant, and El Paso). Companies with an upstream gas play (Questar, Energen, Oneok, Equitable, and Southern Union) also recorded top-quartile performance.

Two growth-oriented utilities stood out in the top-quartile group—Exelon and Constellation. While both of these companies suffered from failed mergers and were “middle of the pack” in terms of 2006 performance, their longer-term performance suggests that investors will be rewarded in connection with growth strategies that are “done right.”

About half of the companies in the bottom quartile were either:

(1) Gas distribution utilities or utilities with a high concentration of gas customers (Washington Gas, Vectren, Peoples Energy, KeySpan, NiSource, Puget Energy); WPS also could be included in this list with its acquisition of gas properties from Aquila (2005) and its announced merger with Peoples Energy (2006);

(2) Energy delivery companies (Central Hudson, Energy East, Duquesne Light, and United Illuminating).

The rest were either solid back-to-basics companies like Southern Co., Ameren, and Great Plains or companies recovering from bad investments such as Teco Energy and Progress Energy.

In looking at group-level performance, the differences are striking. The Integrated Gas group led the way over the three-year period. The Power Generation and Integrated Electric and Gas Utility groups (groups representing utilities with some stake