Investors who want to juice up their sagging stock portfolios probably need look no further than to those who sell the juice — electric utility companies.
These companies are hot, with many posting year-to-date returns of between 30 percent and 60 percent — a performance reminiscent of last year’s Internet cyber rockets.
For much of the last five years, electric utility stocks were not much more than an investing afterthought, and no self-respecting investor would get near them.
Then March arrived, techs dived and suddenly the electric utility industry developed some much-needed Wall Street cachet.
Locally, TXU Corp.’s stock has gained almost 47 percent since March on the strength of projected earnings growth next year of at least 6 percent a year. It was trading at about $35 last week. One of the country’s best utility performers is Houston-based Reliant Energy Inc., whose shares are up from about $22 a share in January to about $40 last week.
“I think what happened in March was that investors began moving away from the volatility of the dot-coms and technology companies and discovered the steady earnings growth and stability of the utility sector,” said Erle Nye, chief executive officer of TXU.
Typically, utilities are conservative, defensive investments that perform well only during a recession.
But recession isn’t the catalyst for this rally, because the U.S. economy is healthy and booming. Instead, utility stocks are the beneficiary of several factors that all converged this year, industry analysts said.
The spring debacle in the technology sector — the Nasdaq composite index dropped 37 percent — certainly set the stage for a rally in utilities, because investors began to look for more sedate places to put their money, industry analysts said.
What they found in utilities was a sector with steady, growing earnings at a cheap price.
Electric utilities as a group were down 20 percent in 1999, one of the worst performing sectors, so “this was one cheap group and safe,” said Barry Abramson, a utility analyst for PaineWebber Group Inc. But given the sector’s dismal performance for much of the 1990s, these factors alone probably wouldn’t have been enough to spark a rally, he said.
The real momentum came from the extraordinary demand for electricity. In fact, in some areas of the country, namely California and New York, demand for power exceeds supply, and that has pushed prices higher and increased revenue.
“This is really exciting,” said Ronald Tanner, a long-suffering utilities analyst for Legg Mason Inc. in Baltimore. “This has been a blockbuster year, and it’s about time.”
Utilities throughout the United States are selling more electricity as demand increases both here and abroad, industry experts said. The population is increasing, the United States has been on a run of exceptionally hot summers, and the demand from business and industry is exploding.
Worth magazine recently reported that a new market is developing for so-called premium power, which is the uninterrupted electricity needed to power data centers, stock exchanges and Internet service providers. This is a $50 billion market that will increase to $500 billion in this decade, according to Worth.
The explosion in demand is fueling optimism for future earnings growth, and that is now being reflected in the soaring stock prices, Tanner said.
Most all utilities are benefiting from this increased demand.
Shares in Duke Energy Corp., a North Carolina utility, have risen from $46.38 in March to more than $80. The stock price of PPL Corp. soared from $18.50 a share to $42.62 in September to make the company one of the S&P 500’s best performers in September. (It was trading last week at about $40.) Peco Energy shares, which hit bottom in late March at $36.69, climbed to more than $59 last week. Reliant bolstered its bottom line by aggressively expanding into the so-called wholesale power generation business, said spokeswoman Sandy Fruhman. Over the last three years it has acquired power plants in California, Pennsylvania and New Jersey and begun selling this wholesale electricity to other utility companies.
“We have more than doubled our generation capacity with this expansion,” Fruhman said. “And this investment is starting to pay off now.”
The concern for investors interested in the sector is that they may have already missed the train. But most analysts say utility stocks still have considerable upward momentum.
“The economy is really strong, and there hasn’t been any significant generation capacity added in 10 years,” Tanner said.
Most of the large utility companies, including TXU, are forecasting 5 percent to 6 percent earnings growth next year. While that may appear anemic compared to the double-digit growth of many of the high tech companies, most utilities also pay a 5 percent to 6 percent dividend.
Supplying power to homes and businesses is a dazzling $200 billion-a-year industry and growing, analysts said, and that doesn’t even include the overseas markets
The nation’s insatiable appetite for electricity has pushed the power grid to the limit, causing brownouts in San Francisco, Chicago and New York.
In California, demand has increased 11,000 megawatts in the last year, Tanner said. “It would take about four huge power plants to supply 11,000 megawatts,” he said.
Even with the recent gains, the price-to-earnings ratio of utility stocks is still about half the P/E of the S&P 500. The P/E ratio is a company’s share price divided by its earnings per share. A P/E about 50 percent of the S&P is well below the historical average, analysts said.
Also, the supply-demand imbalance isn’t expected to be corrected any time soon, and with deregulation sweeping through the industry, some companies aren’t shackled by price restraints, Abramson of PaineWebber said.
Currently, 25 states are in some stage of deregulating their power generation industry, which eventually should increase competition and lower prices, but that’s not happening yet.
“Because of deregulation, in the short run at least, companies can take advantage of the shortages and make more money,” Abramson said. “In a regulated world they couldn’t do that.”
Environmental laws make it difficult and time-consuming to bring new power plants online. Nye of TXU estimates that if a company decided to build a power plant in California today, it would not come online until 2007. That compares with about three to four years in Texas, which has allowed Texas to at least keep up with demand, he said.
“We have added 5,000 megawatts of capacity in the last three years, and we have 10,000 megawatts on the drawing board under construction,” Nye said. “California hasn’t built any new generation in 10 years, and it is importing about 25 percent of its power from out of state.”
Deregulation has brought uncertainty to the industry, and most power companies were reluctant to invest in new plants without a clearer picture of what the new rules would be, Abramson said.
“We have not built enough power-plant capacity to keep up with demand, let alone replaced the aging plants we already have,” said Thomas Hamlin, a utilities analyst with First Union Securities Inc. “The average power plant is 30 years old, and the nuclear power industry is all but dead.”
Most analysts believe demand will outpace supply for at least another three to four years. Tanner said fears about the uncertainty of deregulation are overblown.
He points out that while the generation of electricity is being deregulated, at least 40 percent of the industry, mainly the transmission lines, will remain regulated.
This almost guarantees a steady level of earnings. Said Tanner: “There is no other industry that has a lower risk than this.”
