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Goodbye Safe Haven?

Risk avoidance drives utility stock performance.

Fortnightly Magazine - March 2009
Figure 2

conservative strategies and balance sheets, were the strongest performers in 2008 and the weakest performers in the 2005 through 2007 period.

The returns and strategic rationale behind integrated gas and electric company performance was more varied. Generally, the poor performing integrated gas and electric companies suffered due to liquidity concerns from significant merchant energy and trading businesses, as well as other unregulated investments ( e.g., PSEG, Constellation Energy). On the other hand, stronger performing integrated gas and electric companies maintained their value based on existing acquisition premiums (such as in the Puget Energy acquisition by Macquarie) or the combination of limited unregulated businesses and positive regulatory environments ( e.g., Southern Company, Hawaiian Industries and Pacific Gas & Electric).

2008 was a very weak year for both utilities and the broader market. Only eight of the top 10 performing utilities in 2008 posted positive returns, and four of those eight companies posted returns of 5 percent or less (see Figure 2) . The top six companies include four gas distribution utilities and two energy delivery utilities, all of which exhibited similar strategies, tied to stable dividends, strong balance sheets, good regulatory relationships, and conservative management philosophies. Additionally, of the top three 2008 performers—Laclede Group, Piedmont Natural Gas, and CH Energy—Laclede and Piedmont had rate increases approved by their respective public utility commissions in 2008, while CH Energy filed a rate case with a likely positive outcome.

Figure 3

Among the bottom 10 companies in 2007 (see Figure 3) were three of the four power generation companies, with the other power generation company ( e.g., NRG Energy) coming in as the bottom eleventh company. Also among these bottom performing companies were two integrated gas and electric companies—Constellation Energy and PSEG. These power generation and integrated gas and electric companies all experienced liquidity concerns, which since have resulted in acquisition announcements ( e.g., Constellation Energy and NRG Energy), rumors of acquisitions ( e.g., Reliant Energy) and asset sales ( e.g., PSEG and Constellation Energy).

Given the strong downturn in performance in 2008, it’s not surprising there’s a relationship between 2008 TSR and beginning of year market-to-book ratio (see Figure 4) .2 This is particularly evident for companies with relatively high market-to-book ratios. The integrated gas and electric companies in the portfolio with a market-to-book ratio exceeding 1.6 averaged a TSR of -36 percent; and companies with a market-to-book over 2.0 averaged a TSR of -51 percent. The latter group includes many companies that previously experienced a run-up in share price due to strong nuclear performance ( e.g., Constellation Energy, PSEG, Exelon and PPL). Interestingly, only a subset of these companies ( e.g., Constellation Energy and PSEG) experienced liquidity issues in 2008.

Responding to Challenges

Previewing the stock portfolio’s performance in 2009, questions must focus on how to define future winners and losers. An analysis might seek value from several different perspectives, given the sharp market downturn in 2008, the potential for a continued recession, and a new presidential administration with its focus on clean energy and energy independence:

Figure 4

Potential recovery stories: By the