(September 2007) The impact of dividend policies, capital expenditures, and publicly traded equities highlights an in-depth look at what goes into the modified Dupont Model behind the ...
How to Achieve High Performance
Lessons from the top 40 utilities.
strong financial discipline, it appears as though the market believes there are sufficient attractive investment opportunities in our industry that make better use of cash than increased dividends.
• Profit margins have not been a good predictor of returns, but earnings growth potential is key.
Historical profit margins are not a strong indicator of future earnings growth and TRS; however, companies that can demonstrate strong EPS growth potential will be rewarded (as shown by the strong correlation between estimated 5-year EPS growth rates and TRS). The “back-to-basics” strategy, adopted by most regulated utilities has narrowed the number of strategic degrees of freedom and reduced the number of earnings growth levers. As a result, a number of utilities have resorted to more aggressive cost reduction and operational improvement programs, which are starting to create a significant gap in performance. Between 2001 and 2005, the utilities most focused on cost reduction lowered their costs by 4 percent compound annual growth rate (CAGR), while lagging utilities increased their cost-base by 2.9 percent CAGR (see Figure 3) . This differential results in a 27-percent delta among these utilities over that period, which dramatically affects EPS growth differentials.
• No single strategy dominates the top 40, but a few strategic capabilities emerge.
At first glance it might appear that exploration and production stocks figure prominently in the top 40, but analysis of the percentage of regulated revenue for each member of the top 40 reveals that the list includes a balance of regulated and unregulated utilities (on average 69 percent of the revenue from the top 40 utilities is regulated). Indeed, the top 10 utilities are slightly more regulated than the top 40 overall. In addition, we found no linkage between size and performance, with the average revenue per company being around $5 billion for the top 10, for the top 40, and for utilities outside the top 40. Below high-level strategic positioning, however, we uncovered a number of strategic capabilities that are present within many of the top 40 utilities, regardless of their position along the value chain.
• Step Change Business Transformation: A number of the utilities at the top of this year’s list, including TXU and PG&E, have undertaken a significant transformation of their operations to drive a step change in performance.
• Strategic Agility and Active Portfolio Management: Many of the utilities at the top of the list actively have rebalanced their portfolio through strategic acquisitions, new build, and divestiture of non-core assets. This includes the ability to respond decisively to the cycles of the utility industry with appropriate asset plays ( e.g., seven-year generation cycle). For example:
• TXU’s active portfolio restructuring, including unbundling and outsourcing of capabilities;
• CLECO’s divestiture of CLECO energy gas pipeline organization;
• Duke’s divestment of Spectra;
• PP&L’s shedding parts of its overseas subsidiary;
• Energen’s aggressive E&P investments; and
• Energy South’s aggressive investment in storage assets.|
• Differentiated Asset-Management Capabilities: Active portfolio management cannot be carried out effectively without robust asset-management capabilities (advanced O&M and cap-ex investment planning and prioritization). These capabilities are