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.
to us our payout ratio should look more like the S&P 500’s average, rather than the typical utility. In other words, we’re targeting about 35 percent versus the industry average 65 percent.
We’re not alone in this. CMS Energy reinstated its dividend this year, and Allegheny Energy announced it is looking hard at it too.
Some people think you have to keep the yield high and payout ratio high to attract equity capital. But we’ve been to the point where our financial structure was stretched, and we’re not anxious to return there.
Young: A big question is whether the dividend tax cut will go away in the next administration. If it does, the value of utilities will be hurt and capital costs will go up. That will be bad for customers and investors alike.
But generally speaking, it comes to this: What do you define as a utility?
The utility sector 20 years ago was more homogeneous than it is today. Utilities were regulated companies. But today Exelon is a utility, and 80 percent of our income comes from unregulated businesses. Our nuclear-generation business is tightly linked to the price of electricity, which is linked to natural gas and other commodities. There’s a lot of volatility in that business, and that’s linked to share value. But we also have two regulated transmission and distribution companies, and their earnings stream is a lot more predictable.
We believe the value-return policy needs to be aligned with the earnings profile, capital structure, and risk inherent in the company’s business. The industry is not going back to a homogeneous dividend policy as long as the group is not homogeneous (see “Return of the Pure Play Utility,” p. 44).
Petrosino: In recent years, many utilities were valued more on growth than on dividends. We’ve seen this with PE-multiple expansion for the group, but dividend growth continues to be a selling point. As the equity markets change, it could swing back to utilities being valued more on dividends, especially as investors age and Baby Boomers look for dividends rather than growth. They’ll see utilities as a space to put their assets to work.
Hyman: Dividends are very important for utilities. They make up almost half of the profits shareholders earn. If anything, utilities ought to make sure the dividend goes up. They haven’t done a super job of investing money, and investors would prefer to have it paid to them instead of spent on wild ventures.
Hempstead: From a credit perspective, dividends are viewed as a fixed obligation. To the extent your annual dividend affects your retained earnings, you have less money to reinvest in your system. But if you are spending a lot of money on new generation or grid infrastructure, you are constantly talking to your regulators about rate relief. That increases your regulatory risk and business risks, which means you need higher credit metrics for a given rating category.
Cortright: Utilities have been buying back stock and increasing their dividends. Many are doing that because in the early part of the decade they had such