Understanding power company volatility in the context of valuation theory.
Kevin Phillips is an investment banking associate in the Energy Group of Credit Suisse First Boston in New York. He holds a JD, magna cum laude, and an MBA from Georgetown University. He can be reached at email@example.com, or (212) 325-6103.
Power industry observers have witnessed a stunning rise and fall in the valuations of genco equities over the past year. The first half of 2001, marked by high power prices and forecasts of a capacity shortage, saw genco equity prices peak at earnings multiples rarely seen before in the power industry. During the second half of 2001 and the beginning of 2002, observers witnessed the prices of the very same stocks decline to earnings multiples usually seen only in distressed situations, as overbuilding fears drove down the forward curve and as Enron-driven liquidity issues led investors to flee the sector.
In explaining the dramatic volatility of power sector stock prices, commentators have pointed to a variety of factors, including weather, the economy, price caps, transmission constraints and of course, the Enron effect. These and other factors have had an impact on valuations and have also guided investors' evolving understanding of the sector by highlighting the industry's critical valuation drivers. For industry observers trying to make sense of the dramatic swings in equity prices seen in the past year, it is helpful to consider the industry in terms of a valuation framework commonly applied by investors.