Adopting digital capabilities to transform operations and processes holds immense promise for utilities. Indeed, it’s the best path to growth.
2007 Finance Roundtable: Pricing Regulatory Risk
Despite a favorable outlook for utility finance, cost pressures are straining rate structures.
a focus on recovering the strength of their balance sheets, now they’re returning to focus on the equity side.
But realistically, this industry is going into a buildout mode, and those sorts of practices will have to slow down—unless they are OK with threats to their credit quality. Companies need strong balance sheets as they go into these very stressful periods.
Sauvage: Historically utilities have under-earned during big cap-ex buildout phases.
I’d expect payout ratios to edge up a little bit, depending on cap-ex plans and regulatory treatment. A lot of the capital going in at this stage—advanced metering and other grid infrastructure—should get into the rate base more quickly than long-term generation investment. This is particularly true for companies that are going in for rate cases frequently.
Maloney: Utilities no longer own all parts of the value chain. They are service providers of last resort, and more procurement is coming outside of cost-of-service regulation. Look at how technology has evolved and how uncertainties in demand have shifted. Given this risk, is this the same stock you tried to sell to widows and orphans 30 years ago?
Arguably utilities should be getting higher returns for the capital employed. Regulatory policy has a very important effect on what utilities do and the risks they face. That’s even truer today than it was before. At the end of the day they are facing greater risks, but simply adjusting the dividend may not be sufficient to deal with those risks.
Nastro: At this point in the capital-investment cycle, there’s a natural tension between credit quality and equity returns.
And the cap-ex bubble is not yet reflected in valuations, as can be seen in the limited differentiation between the highest and lowest PE-ratios in the sector. Utilities are expected to need $60 billion in external capital between now and the end of 2010. We’re at the front end of a period of rate-case filings. Historically, regulatory pressure has compressed returns on equity.
Eventually the market will start to differentiate between winners and losers based on regulatory environment. States that use performance-based rate-making, provide incentives for infrastructure growth, and favor settlement over litigation will provide a more attractive regulatory backdrop to attract needed capital.