Measuring Up to Jensen
A top investor explains what it would take for utilities to be included in one of the best-performing funds in the U.S.
Passing the standards for inclusion in the $1 billion plus Jensen Portfolio Fund is like being crowned the best-of-the-best in a given industry, analysts say.
That's because only the best-of-the best could support a fund that has managed to beat the S&P 500 in an economic downturn. In fact, the Jensen Fund has generated an impressive 2.25 percent a year over the 36 months to December 2002, against a 14.53 percent annualized decline in the S&P 500. During the recent economic boom, the fund delivered double-digit returns.
But to date, the investment fund has yet to include a utility stock. The fund chooses stocks using one bedrock criterion: Jensen wants companies that have posted a 15 percent or better return-on-equity (ROE) in each of the past 10 years.
Furthermore, Val Jensen, chairman of the fund, says the impact of non-recurring earnings is reviewed on a case-by-case basis to identify long-term performers that may have had a few bad years.
According to the Forbes Best Buy List, the average return on equity (ROE) for S&P 500 companies is 17 percent; the average for the Jensen Fund is 24 percent. The ROE screen alone narrows the field of candidates from 10,000 publicly traded firms to around 100 companies, according to Jensen. Then, to decide the true value of a company without regard to its current market price, the fund determines an "intrinsic value" for each of the candidates by calculating the present value of the company's estimated future free cash flows. Furthermore, the Forbes list says this discounted earnings stream is added to a pessimistic valuation of the company at the end of 10 years, which assumes just 5 percent subsequent cash flow growth.
"They want companies trading at no more than 60 percent of this hypothetical intrinsic value. Even the finalist has to be a leader in its industry and boast a stellar credit rating," says the Forbes Best Buy List report on the fund. Companies in the fund include Coca-Cola, Johnson & Johnson, Merck, and Colgate Palmolive.
Jensen says utilities traditionally have not had a high ROE, so they have not been on his list. Southern Co. has consistently produced 12 percent ROE, but never as high as 15 percent.
Furthermore, in 1992, when the fund was started, profit was regulated, so utilities were not attractive, he says. When utilities were able to get outside of the regulated sphere, "they got so far afield outside their expertise they probably didn't know enough about the businesses they were getting into," Jensen says.
In fact, Jensen remembers looking at Duke Energy early on as an investment candidate. "They did a marvelous job until they got caught up in the energy trading aspect, which was a blow that the utilities never needed. The return on trading commodities, whether you look at Enron or anybody else, is terrible. It is a very competitive environment, and no one can keep an edge for very long," he says.
Jensen says Duke had consistently provided 15 percent ROE (making it a candidate for the fund) since 1997, but it dropped to 8.5 percent ROE in 2002, disqualifying the utility from considerration. Nevertheless, Jensen still says Duke is one of the top utilities and might have made the fund had the utility not gotten involved in energy trading.
Moreover, Enron-the darling of many prominent investment funds over the last 10 years-never made the grade.
"Enron never qualified. In fact, after it entered the trading business margins dropped significantly, as did ROE. We never looked at it," he says. This is not to say that Jensen would shrink from the cyclical nature of merchant power plant development companies. He says that if a company has been growing at 15 percent a year and has a flat year, that does not mean that it won't continue to grow at 15 percent. Naturally, Jensen notes that no independent power producers have been able to meet his criteria-but he suspects they will at some point.
Furthermore, Jensen has found that companies that sustain earnings of 15 percent rarely migrate from the list. "If they get there, they stay there," he says. The electric utilities Jensen believes could make it into the fund in the next five years or more are PPL (which is the closest), PSEG, TECO, Dayton Power & Light, and in gas, NICOR. For utilities that have made double-digit returns in the last few years and which had the highest ROEs (although none meet Jensen's 10-year/15 percent criteria), please see table 1. (Editor's Note: This column analyzes financial developments and discusses financial issues. This is not a solicitation or investment advice.)
Business News Bytes
Dynegy Expects To Beat Consensus Estimates for 2003
Dynegy said it expects to post a full-year net profit of $31 million to $54 million, or eight cents a share to 15 cents a share. Wall Street analysts, on average, were projecting that the company would earn three cents a share, according to Thomson Financial/First Call. Operating cash flow, including working capital changes, is expected to be $1.2 billion to $1.3 billion in 2003. The estimates don't include businesses the company is currently exiting, such as communications and third-party marketing and trading. In terms of liquidity, the company said it maintains $1.47 billion, including $915 million in cash and $1.4 billion in bank lines. The company also said it reduced its bank exposure and debt by roughly $850 million and plans to repay another $100 million later this month.
Calpine Delivers New Plant to Wisconsin Public Service
WPS Resources Corp. subsidiary Wisconsin Public Service Corp. announced Dec. 17 that it had completed its $120 million purchase of the 180-MW De Pere Energy Center from Calpine Corp. WPS says in a release that the acquisition was structured to include a $72 million payment at closing and a $48.4 million payment in late 2003. In addition, the deal includes the termination of an existing power purchase contract and the enactment of a new 10-year, $250 million agreement for WPS to buy up to 235 MW from Calpine's proposed Sherry Energy facility. The Sherry facility will be located near Marshfield, Wis.
Kinder Morgan Projects Growth in Earnings in 2003
Kinder Morgan announced that it expects recurring earnings of $3.11 per share in 2003, representing 16 percent growth over 2002 consensus estimates. The expectations include contributions only from assets currently owned by KMI and Kinder Morgan Energy Partners. Expected cash flow in 2003 is approximately $450 million.
Allegheny Energy Reports $334.4 Million Loss in Delayed 3Q Results
Allegheny Energy Inc. reported nine-month results for the period ending Sept. 30. The company announced on Nov. 4 that it had to delay the release of third-quarter earnings because of an ongoing financial review. For the period, Allegheny lost $334.4 million, or $2.67 per share. The results include a reduction in the market value of its trading portfolio, reflecting changes in valuation model assumptions and market conditions, and the affect of an accounting change related to the adoption of SFAS 142, among other factors.
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