Investing in Utilities, Still a Safe Bet?
- Jan 4, 2022 5:18 am GMT
The Stock Market Crash of 1929 marked the start of The Great Depression. Prior to the crash, the bank stocks were significantly overvalued relative to earnings and assets, public utility holding companies included. After the news regarding utility regulation, stocks fell dramatically and buyers began selling in a panic. Since then, Congress enacted the Securities Act and the Exchange Act and the federally-owned electric utility corporation, Tennessee Valley Authority (TVA), was born. Over time, investing in utilities became synonymous with predictability, recession resilience, lower volatility, and steady dividends.
Despite more recent market declines, due to the pandemic or otherwise, utilities generate reliable earnings, pay dividends with above-average yields and make for a safe, stable, predictable investment. However, there is always an exception to the rule. Utilities have taken on more debt to build a renewable energy infrastructure. More depth means more risk. Duke Energy announced an ambitious five-year $58 billion spending plan last year. The plan calls for large investments into renewables, battery storage, energy efficiency programs, and grid projects. Duke’s total long-term debt is approximately $57 billion. If that capital spending was to be financed through the bond market, it would double Duke’s long-term debt. This creates a problem for current and potential shareholders. During an economic downturn, investors may brood a bit longer before jumping in. Unregulated utilities present another challenge as their markets are not guaranteed and competition can make for inconsistent cash flows when commodity prices change. Comparatively, regulated utilities are still considered a safe bet. "As the United States looks to 'green' its power fleet, electric utility companies are on the brink of a multiyear evolution that offers a long runway for growth," Douglas Simmons, a Fidelity utilities sector portfolio manager, predicted in a Dec. 2020 outlook report.
Duke Energy hopes to make their valuations more attractive and tailor minority investments by selling minority stakes in specific regulated subsidiaries instead of to the parent company. This approach provides regulated utilities an opportunity to strengthen their financial position and meet their capital needs. A Guggenheim Securities analyst noted that "(Duke Indiana) transacted at what we view as a very attractive multiple and is accretive to earnings and credit.” Duke Energy's chair, president and CEO, Lynn Good, said in a recent press release about the two-phase minority sale, “This transaction will allow us to accelerate our clean energy strategy across our regulated utilities.” According to analysts, other companies with strong financial profiles include NextEra, Consolidated Edison and American Electric Power Company (AES).
Financial investors are looking for negotiated governance rights and investor protections, steady distributions, capital expenditure growth potential, targeted exposure to specific regulated businesses, a lighter regulatory approval process and an investment sizing in the $1-3 billion range. According to Energy Regulatory Attorney, Raunaq (Niqui) Kohli, “Finding an investment opportunity with all the right characteristics, as well as utility-style regulated earnings, is exceedingly rare…” How is your utility justifying increased debt to investors? Will minority investment transactions improve valuation? Can investing in slow-growing, low-risk companies like utilities help stabilize the market?
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