Rounding Up Utility Losers of 2013

 | Jan 06, 2014 | 7:10 PM EST  | Comments
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Most electric and gas utilities provided solid returns in 2013. As was described in Rounding Up the Big Utility Winners of 2013, companies like MDU Resources (MDU), Black Hills (BKH) and NiSource (NI) offered investors with returns in excess of 35%.

On the other end of the spectrum, several companies struggled to finish 2013. The most disappointing company is FirstEnergy (FE). Even after a 7% dividend, FirstEnergy's investors lost more than 16% in 2013.

With an enterprise value over $30 billion and a footprint in six states, FirstEnergy is large. It is diversified. Most of their assets are regulated. Some of their generation is deregulated.  

FirstEnergy's regulated assets are valuable. They own 20,000 miles of interstate transmission lines, which is regulated by the Federal Energy Regulatory Commission. They also own 10 regulated distribution companies, which are regulated by state utility commissions.

FirstEnergy owns approximately 18,000 megawatts of generating capacity. Their portfolio is approximately 56% coal, 22% nuclear, 11% renewable energy (wind and solar) and 8% natural gas. Approximately 94% of their generation portfolio is non-emitting, low or scrubbed.

Most of FirstEnergy's generating assets operate in the PJM Interconnection. As such, most of those assets should earn higher capacity payments over the next three years (assuming all cleared PJM's capacity markets). Starting this Spring, capacity payments jump. They jump again 12 months later.

Revenues for energy should also increase. PJM's transmission lines are currently constrained. Constrained lines make it difficult for companies like FirstEnergy to deliver their product to market. As those constraints are eliminated, most of FirstEnergy's assets should see higher demand and prices.

Nevertheless, some of FirstEnergy's assets may be forced to retire early. While they may comply with environmental regulations, their production costs could exceed locational market prices. Of particular concern is one of FirstEnergy's four nuclear power plants. Their Davis-Besse unit operates near Toledo Ohio, and it has high operation and maintenance costs.

Finally, FirstEnergy is ushering in a new management team. After they settle in, big changes are in store. It is likely some assets will be written off. This could also be the time to "right-size" the dividend. If an announcement to write off assets or cut dividends is made, the stock could react strongly.

Another underperforming utility is Exelon (EXC). After dividends, investors took a 6.5% loss. This is not a surprise. Most of their news is known. Like FirstEnergy, Exelon should see better top lines in the last half of 2014. Like FirstEnergy, Exelon will likely announce more write-downs. Unlike FirstEnergy, Exelon should not be cutting dividends (although they surprised me 18 months ago).

Four utilities offered investors no returns. Consolidated Edison (ED), PG&E Corporation (PCG), Entergy (ETR) and Pepco Holdings (POM) each offered investors healthy dividends that essentially neutralized their capital losses. For the most part, investors in these companies gained nothing and marked time.

Four utilities offered investors meager returns. Southern (SO) and Edison International (EIX) provided investors with only a 2% return. SCANA (SCG) offered a 3.8% return. TECO Energy (TE) offered a 4.8% return. Duke Energy (DUK) was slightly below 10%. By comparison, NiSource offered its investors a 35% return.

There is a pattern among the underperforming utilities. One appears to be geography. In particular, southeastern utilities seem to have fared worse than did their contemporaries in other regions.

Another is nuclear. Entergy, Southern, SCANA, Duke, Exelon and FirstEnergy each own several nuclear power plants. Southern and SCANA are in the process of building more nuclear plants. It appears investors have growing concerns about these plants. They worry about nuclear economics. They worry those economics will harm earnings.

Finally, most of these companies appear to have low price/book ratios. As Real Money's Tim Melvin instructs, low price/book ratios are one of several essential requirements for value investors. Melvin argues the ratio should be less than one.

As the graph indicates, several companies appear to have ratios approaching the Melvin threshold. However, those numbers may change should management decides to write down assets. The odds are high there will be new write-downs in 2014. Consequently, some of these ratios may not be as close to one as they appear.

Entergy is a concern. As was previously reported, they may be forced to write down several nuclear power plants. 

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