In recent years, some investors have relied on the big electricity companies to insulate them from the typically unpredictable world of stocks. It's been a hum-drum sector known for conventional business practices, a distaste for risk, minimal growth and, perhaps most important, reliable and constant dividend flows. Well, the times they are a-changin', and fast. The sector is getting a major facelift as deregulation opens it up to some giddy growth opportunities and, as a result, plenty of risk. Before deregulation, power companies were limited to generation and transmission of energy within a specific geographical area. While state regulators put a floor under earnings, they also put a ceiling on them, and a pretty low one at that.
In this brave new world of deregulation, companies are allowed to sell generation and transmission services outside their former monopoly territories. They are no longer guaranteed earnings. And they can expand into natural gas, independent power development, power-line construction, cable distribution, telecommunications and foreign markets. Several companies are opting to stay in the distribution business, but others are rushing to diversify. The pluckiest of the bunch are focusing on what has become a high-stakes generation and commodity trading market. The first group remains a slow-growth, low-risk investment, while the other two are morphing into high-risk, high-yield growth plays. And that means investors have to look before they leap. "The key is that deregulation just changes the total paradigm that a utility operates under," says David Parker, a senior vice president and research analyst at investment bank and brokerage Robert W. Baird. "The challenge for investors today is understanding that you need to be very careful about what you invest in. It used to be that you could buy any utility because they were all very similar. But you can't do that any more. Today, I divide them into three different groups, each of which is very different in terms of returns and risk," he says.
Some recent deals include the acquisition of New Jersey's GPU ( GPU) by Ohio's FirstEnergy ( FE), a merger of equals between FPL Group ( FPL), which controls Florida Power and Light, and Louisiana's Entergy ( ETR); and a merger between Philadelphia's Peco Energy ( PE) and Chicago-based Unicom ( UCM). "There are only going to be a couple of winners," said Andrew Levi of Credit Suisse First Boston.
|Playin' It Safe |
|American Electric Power||AEP|
|Second Tier |
Risking ItChoosing the appropriate risk level may not be enough. Investors have to watch companies, as well as oil and gas prices, carefully. Companies that step into the deregulated arena are going to face a lot of competition, not just from other utilities, but also from interlopers from outside of their industry. They'll also face pressure from Wall Street, which has worked itself into a tizzy over some of the higher-growth opportunities in the sector. California-based independent power producer Calpine's ( CPN) stock, for example, has soared more than 150% since mid-April and is now trading at a price-to-earnings ratio of 64. Some of the recent strength is due to extremely tight supply in California, which has jacked up power prices to unprecedented levels. "I think the excitement and higher expectations from Wall Street does raise risk. Some companies' managements are trying to keep up with the Joneses. I want companies that really know what they do well and won't have an identity crisis," Parker says. The different players in each group will likely shift and swing as companies continue searching for the perfect niche. A spate of mergers, acquisitions and spin-offs has been stirring up the sector since last year and is expected to continue.
|High Stakes |