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The Pulse of a Utility

The market-to-book ratio is a vital sign of a utility’s health.

Fortnightly Magazine - January 2009

after 2007 from the very utilities that touted them in the mid-2000s. With their favorable low water mark fading into the sunset, they soon will have to develop a new, more convincing argument to demonstrate outstanding performance.

Many traditional utility managers love the classic enterprise measures—earnings per share (EPS), growth in earnings, dividend rate, dividend yield, and the like. Unfortunately, these measures either fail to offer an element of comparability for external stakeholders ( e.g., EPS) or merely reflect financing decisions ( e.g., dividend-related measures) rather than effective performance. Worse, many of these measures are, in fact, indicators of the opposite of what they purport. For example, a high dividend yield is most commonly a function of a falling share price, rather than a surging shareholder payout, and a precursor to a cut in the dividend rate.

These traditional measures won’t go away any time soon. They have become a sort of shorthand communication between executives and their boards of directors and between the companies and their investors. Unfortunately, although they are comfortable for their familiarity they offer very little real situational insight or relative comparison for stakeholders.

Predictable Patterns

Finally, an ideal enterprise-level performance measure should offer key stakeholders (especially independent board members) a quick and clear sense of the company’s status in terms of the key macro trends and issues it faces. As both a capital-intensive and regulated industry, here is where a utility’s market-to-book ratio has very predictable patterns that offer insight into future events. Three obvious areas of this predictive power include market expectations about the future ROIC, share price performance (especially around rate case years), and governance events.

First, the MtB ratio and the market’s expectations about the utility’s future ROIC performance are highly correlated (0.69). Thus, the MtB ratio really is signaling to stakeholders what others expect about the future performance. Thus, a rising or falling MtB ratio (especially changes relative to industry averages and historic levels) are noteworthy events and they warrant further examination.

Second, the regulated nature of the industry also is clearly apparent in a utility’s MtB trends. For example, the periodic rate-case process is inherently a leveling one. Not only are operating costs and rate base readjusted, but allowed return on equity is reset to a theoretical industry average level. Thus, astute observers would expect the MtB ratio of a utility to exhibit a clear regression to the mean pattern around the time of a rate case.

This regression to the mean is exemplified by We Energies, which has had multiple rates cases throughout the 2000s (with authorized increases through 2009) and its MtB ratio concurrently has mirrored the industry average (see Figure 5) . Similarly, Alliant Energy (multiple cases since 2003), and United Illuminating (2006 through 2009) also have exhibited this regression to the mean concurrent with recent rate orders.

Last, consider the topic of change-of-control events such as survival mergers (effectively, friendly takeovers often engineered by stakeholders) or unsolicited offers or takeovers. A clear pattern results from examination of the MtB ratio of several U.S. utilities that have ceased