Revisiting 10 Trendsetters

We check in on the 10 utilities we identified in December as the industry's leaders.
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As we enter the dog days of summer, it's time for the midyear utilities checkup. On the last day of 1998, Power Lines provided a list of 10 utilities that would be at the forefront of industry trends in 1999.

What we didn't foresee was the triple dose of bad news that has plagued utilities in the first half of 1999. These include a continuing uncertainty over the progress toward deregulation, a concern that utilities' efforts to get into deregulated businesses would lead to declining dividend payments and, finally, a rise in long-term interest rates, a distinct negative for an industry with traditionally high debt ratios. As a result, the

Dow Jones Utility Average

has risen a paltry 3% so far this year, well below the

S&P 500's

rise of 14.2%.

None of this means that investors should avoid the industry, but it means that those who do will need both patience and a keen sense of stock selection as the pieces of the deregulation puzzle are put together. That said, here's a quick update on the 10 trendsetters we identified and what's in store for each for the rest of the year.

American Electric Power

(AEP) - Get Report

is finally completing its merger with

Central & South West

(CSR)

, which will create a powerhouse from the Ohio River valley to the Rio Grande. Once the project is completed, American Electric will look to other partners to solidify its control of the north-to-south transmission grid in the central U.S. However, the uncertainty of the merger with Central & South West caused the stock to drop more than 22% since the first of the year. Because much of the price decline is investor impatience with the merger, the shares will likely recover once the merger is complete.

AES

(AES) - Get Report

continues to click on all cylinders. While last year brought international challenges, the company's development and purchase of generation assets in the U.S. kept its growth on track. A good international performance in the first half of 1999, the pending completion of the

Cilcorp

(CER)

merger and the growth of its domestic merchant generation business add up to a profitable six months for investors. AES shares are up more than 24% since the beginning of the year. If the company continues to execute its business plan, the stock should continue to perform well.

Consolidated Edison

(ED) - Get Report

, serving New York City, has more retail customers than any other domestic utility. And, after the recent oppressive heat wave and power outage, it's safe to say the company has more angry customers than any utility as well, contributing to the shares' fall of 14.5% since Dec. 31. But notwithstanding the heat-related trials, Con Ed is poised to become the major retail "wires" company -- focused on distribution of power to end users -- in New York. As consolidation continues in New York, look for Con Ed to be a buyer.

Duke Energy

(DUK) - Get Report

, serving the mideastern seaboard from its North Carolina headquarters, is one of the best-managed utilities in the U.S. and consistently one of the most profitable. That hasn't helped its share price, which has fallen 14.5%. Both its traditional utility operations and its relatively new power-trading business continue to meet management profit targets. Duke, however, has been relatively quiet since the beginning of the year, suggesting the company is focusing on internal growth. But look for the company to make overtures to its neighbors in South Carolina and Florida when the time is right.

Enron

(ENE)

continues to knock the cover off the ball. Its power-trading, international operations and domestic utility holdings continue to perform well. The company's recent decision to pioneer bandwidth trading is just another indication of its trailblazing spirit. Investors like Enron's style: The shares are up more than 48% this year, and the company will likely remain a leader in new energy ventures.

LG&E

(LGE)

continues to lack vision. After last year's summer price spikes led to LG&E's exit from the energy-marketing business, rumors have persisted that the firm is looking to merge with another entity. The company refuses to comment, but a merger with

Cinergy

(CIN)

was only moments from completion when negotiations stalled earlier this year. LG&E's shares have fallen 24.7% this year, but as the stock continues to languish, a number of utilities will probably look closely at this Kentucky utility. It could find a dance partner in time for the New Year's ball.

PG&E

(PCG) - Get Report

is quietly growing its energy trading and marketing businesses from its Houston outpost. Although competitors such as Enron and

Dynegy

(DYN)

tend to steal the headlines, PG&E has become a competitor for major accounts, including, sources say, a potential deal with a utility in the Southwest to control additional generation assets. The stock is up 4.2% this year and should continue to rise along with the company's earnings growth.

PECO Energy

(PE) - Get Report

, once the staid Philadelphia utility, has become a major player in the consolidation of nuclear generation assets. In partnership with

British Energy

, PECO is buying nuclear assets across the country, in many cases for pennies on the dollar. In addition, the company is increasing its energy-trading business, focusing on Northeastern markets. Investors have blown both hot and cold on the shares, which were up as much as 20% in early May, but have since tumbled, giving the stock a gain of only 1.8% year to date. The company is well positioned to grow its energy-trading and nuclear consolidation businesses as electric deregulation progresses.

Southern Co.

(SO) - Get Report

, the largest generator of electricity in the U.S. and the second-largest electricity trader in the country, is aggressively buying electric generating assets, recently completing deals for power plants in New York, Massachusetts and Texas. The company's international presence is growing, with a new energy-trading operation in Amsterdam. However, the stock has languished this year, losing about 7% of its value. Two problems: Investors are concerned there is little coordination among Southern's diverse units, and many analysts feel Southern needs to expand its presence in natural gas, something it tried but failed to do in talks of merging with

El Paso Energy

(EPG)

. CEO Bill Dahlberg knows the issues are important to investors and is addressing both. Action is likely by the end of the year.

Western Resources

(WR)

is a utility in

transition. Although it has consummated many deals, execution is a problem. The merger with

Kansas City Power & Light

(KLT)

is yet to be completed, and its purchase of

Protection One

(POI)

has been laden with problems, including an inquiry by the

Securities and Exchange Commission

. All that has helped the shares tumble 20.5% so far this year. But CEO David Wittig has hired new management support to address execution issues, and he recently implemented a new compensation structure wherein senior executives of the company receive a majority of their pay in Western shares.

So, there you have it, a midyear progress report on the 10 utilities to watch. Remember, this doesn't represent a recommendation list, but rather an effort to identify those companies on the leading edge of change in a rapidly evolving industry.

Do you have opinions on these 10 or others to watch? If so, shoot me an

email with your ideas and I'll reveal them in a future column.

KN Energy Ties the Knot, Again

As we recently

suggested ,

KN Energy

(KNE)

didn't wait long to find a new partner after its painful split with

Sempra Energy

(SRE) - Get Report

. The company announced late Thursday a merger with

Kinder Morgan

, a privately held Houston-based energy pipeline company. While the deal calls for KN to purchase Kinder Morgan for just under $506 million, it is the latter's chairman, Richard Kinder, who will assume the post of chairman of the combined companies. KN Energy CEO Larry Hall resigned immediately upon announcement of the merger.

With a hefty debt level and continued troubles integrating its acquisition of

MidAmerica Energy

, KN had little choice but to merge with a company that could shore up its balance sheet and provide new leadership. The merger will lower KN's debt-to-market cap from 72% to 65% and should boost the company's earnings in the first year. The combined companies will further reduce debt by selling nonstrategic assets, which could include KN's small position in electric generation.

The news helped boost KN Energy's shares, which had dropped to under 12 following the KN-Sempra split. The shares closed Friday up more than 6 a share to 18 7/8, suggesting investors feel a combination is in the company's best interest as well.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At the time of publication, Edmonds' firm was long PECO Energy and Protection One, 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 at

invest@cjnetworks.com.