It was anything but a power surge that hit Hawaiian Electric (HE) - Get Report this week.

The tropical electric utility-turned-savings bank holding company lost some juice after announcing lower-than-expected earnings Monday. Hawaiian Electric reported earnings of 66 cents per share, well below the consensus estimates of 83 cents per share.

Weakness at the company's savings bank might've been expected, given a struggling economy and difficult comparisons with 2002, but the electric utility actually provided the disappointment. That led traditional utility investors to flip the switch and run Tuesday, and that pushed the stock below $40 before it recovered to close at $40.01.

When I first

profiled the company last July, I suggested its stock looked attractive around the $40 level when the yield broke through 6%. After the recent earnings miss, it's time to take another look.

Surging Expenses

Hawaiian Electric's utility net income sank 13% in the first quarter of 2003, to $17.7 million vs. $20.4 million in the year-ago quarter. Although the company posted solid gains in power sales, those were more than offset by soaring retirement-benefit costs and higher depreciation expense. The company wasn't clear on the lingering impact of retirement expenses but was somewhat cautious about continued growth.

"Increases in residential usage and the number of residential customers as a result of a strong real estate market in Hawaii helped to boost kilowatt-hour sales by 2.5% for the quarter," said Robert Clarke, Hawaiian Electric's chief executive, when announcing earnings. "Going forward, the full impact of the conflict with Iraq on the Hawaii tourism industry and the company's kilowatt-hour sales growth is still unknown."

Power Outage
Weak earnings send Hawaiian Electric lower

It will likely take another quarter or two to determine whether the company can control expenses. In the meantime, continued terrorism risk, an anemic economy -- both domestically and in Asia -- and the new threat of SARS will probably affect the Hawaiian tourism trade, the state's economy and, as a result, short-term power demand.

Because of the cautious outlook and expense issues, consensus estimates for per-share earnings have come down to $3.07 from $3.10 for 2003 and are now $3.28 for 2004.

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Banking on Success

Despite the utility's challenges, Hawaiian Electric's bank segment did post a solid quarter. American Savings Bank, Hawaii's third-largest bank, saw earnings increase 1% as credit quality improved and net interest and other income posted gains. Again, however, expenses were an issue as the company works to turn itself into a full-service community bank from a traditional thrift. That rise in expenses was expected.

The company has also worked diligently to refocus itself on Hawaii after a couple of unsuccessful international ventures in the Pacific. Although earnings were challenged in the first quarter, Hawaiian Electric has made strides in reducing both business risk and earnings volatility. As management regains control of expenses, the company should begin to trade more like a typical utility with a "bank kicker." About 65% of its earnings now comes from the electric utility, with American Savings Bank providing the balance.

In addition, legitimate expenses at the utility may eventually be rolled into the rate base. "Gradually, we would expect electric-rate relief to more effectively deal with this problem," said David Schanzer, utility analyst at Janney Montgomery Scott. He rates Hawaiian Electric a buy, and his firm has recently provided investment-banking services to the company.

Playing the Yield

Can Hawaiian Electric regroup and post good results the balance of the year? And is now the time to jump in with hopes of catching one of those famous Hawaiian waves?

Tourism remains a concern for earnings at both the utility and the bank, but I'd be surprised to see Hawaiian Electric post annual earnings below $3.05 for this year. Moreover, I'd expect a rebound -- conservatively -- to the $3.30 level in 2004. I think the company's expense issue will be resolved -- either through better efficiency or the rate base -- in the next two quarters.

At current prices, the stock trades at about 13 times earnings. Historically, it has been fully valued at 14 to 15 times current-year earnings, suggesting price potential around $44 in the next 12 months. When that's combined with a 6% current yield, Hawaiian Electric still looks attractive to patient, long-term, income-focused investors.

Despite the risks -- economic, regulatory and management -- at both the utility and the bank, I still think Hawaiian Electric presents an interesting opportunity when the stock trades at about $40. It worked last year, and I think it will work again. I'm maintaining the two-barrel rating, and Hawaiian Electric remains in the Bottom of the Barrel income portfolio. (For an explanation of our barrel rating system,

see our description.)

Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.