Analysts: Down on utilities. Is the party over? That’s the tough question posed in a research note by Wachovia equity research analyst Samuel Brothwell.
High Performance? Your Strategy Matters
Leadership requires alignment between performance measurement and strategic priorities.
What defines high performance in the utilities industry? Who will be the winners? And what factors suggest long-term, sustainable leadership? These are tough questions—the seminal questions of business.
In a stable, relatively homogeneous regulated market, measuring performance leadership is somewhat predictable. In today’s changing market, however, it’s become complex, opaque, and the fodder for endless debate. More important, measuring performance has become as misleading as it is illuminating, typically failing to provide much insight on future performance, long-term potential or looming performance threats. While analysts attempt to sort this out for investors, the question remains: What really matters?
In the end, there is no short and simple answer. However, there are a few themes to keep in mind when evaluating industry performance assessments:
• Market sub-segments exist, and the definition of leadership varies among them;
• A spectrum of measures is better than one measure, providing reinforcing and countervailing indicators;
• Because they best align with your strategy and value-creation model, over-weight measures;
• A future versus historical bias should be maintained, e.g., trend metrics that “suggest” future performance; and
• Metrics should indicate actions—strategic changes and capability gaps to fill.
Performance Leadership Depends On Who Measures It
During the past 10 years, there has been little consistency in utility performance. Sustained leadership, in terms of total return to shareholders (TRS), has been practically non-existent as the market has ridden out the wholesale debacle, the return to basics, and significant asset repositioning and merger activity.
As utilities shifted from strategic growth to improving core operating performance post-Enron, reducing costs and risk, utility stock prices responded. The S&P 500 Utility index rose 20 percent in 2004 and 17 percent in 2005, boasting an average dividend yield of 3.3 percent—nearly double that of the S&P 500 during the same period. Was the market actually responding to improved core operating performance? Was it anticipating growth and consolidation? Or was the market simply responding to low interest rates, wholesale workouts, and a general investor flight to safety? The answer to all these questions is a qualified “yes.”
To some, high performance is defined by superior profit margins, asset turnover ratios, and return on assets (ROA). To others, high performance means achieving the highest TRS or the greatest spread between return on invested capital (ROIC) and weighted average cost of capital (WACC).
The Fortnightly 40 takes another approach: a hybrid model that incorporates historical growth trends and force-ranks performance against key elements of the classic DuPont model.
Each approach yields a different list of high performers, but only two companies—PG&E and Energen—appear on all four lists (see Table 1) .
While none of these rankings provide a complete performance picture, in aggregate, they do provide a set of insights into what the market is valuing. A key question revolves around the apparent