OCTOBER 2014 The Research Guide to Electric Utility Investing 39
Research Guide To ELECTRIC UTILITY INVESTING 2014
of these sectors does not significantly
different from our pre-2014 expectations, as we had already projected
strong growth from this industry.
Shaughnessy: Given the poor
relative returns from the sector in
2013 and the very cold winter in the
beginning of 2014, we were not surprised to see a strong snap back in
Simmons: Most investors were
surprised at the extent of
the broad-based rally in all
utilities thus far in 2014.
Both regulated utilities and
deregulated generation utilities performed exceptionally
well. The entire group saw
very strong performance
regardless of how regulated
the companies were or how commodity sensitive the companies were.
The utilities that were more sensitive to power benefited from a rise in
power prices, and the regulated companies benefited from lower interest
rates and heightened volatility as investors sought out less volatile, more
What factors (regulatory, economic
growth, weather, interest rates,
etc.) most influence electric utilities?
Kohli: All of these factors are important, yet long-term interest rates will
likely continue to have the most influence on the return of regulated utilities; the correlation between the stock
returns of these companies and the
long-term bond yields being offered
in the market remains high.
This influence will exist in both the
intermediate- and long-term. A stronger economy will probably help independent power producers and integrated electric returns as supply/demand
fundamentals for electricity improve.
Pursche: As demonstrated by this
past winter, weather can be a major
force in driving profitability of electric
utilities in the short term. We believe
that from a long-term outlook, interest
rates and economic growth will have the
broadest impact on overall performance
of companies within this utilities sector.
Shaughnessy: Over the intermediate to long term, which I’ll define
as several to many years in length,
electric utilities should be influenced
mostly by economic growth and the
Interest rates will most
likely have some influence on
the space, as utilities and other
higher-yielding sectors tend
to face headwinds during periods when rates are moving
significantly higher at a quick
pace. The weather, as evident
in early 2014, can impact utilities’ returns over shorter time periods.
Simmons: From a macro perspective, it is interest rates. With interest
rates still near record lows, there is
heightened risk and focus on interest
rates moving higher, so the
group is very sensitive to any
signals that rates may go up.
The stocks which will be most
exposed upfront to the beginning of an upward rate cycle
will be the lower-growth,
At the micro level, it is the
regulatory environment specific to each
company in the state where they are operating that will most influence their longer-term returns. Having a reasonable
and balanced regulatory environment is
a must for successful investing within the
utility sector. It’s difficult to own a utility
that does not have a reasonable and predictable regulatory environment.
Spratt: All these factors have an influence on utilities, but often in multiple ways, and the magnitude can vary.
It was a hard, cold winter, and we were
reminded why utilities work so hard
to maintain extra capacity and reserve
margins to meet the demands that
weather brings. Mother Nature always
plays a major role in the level of con-
sumption of electricity and natural gas.
Interest rate movements and the
Fed tapering likely impacted utilities in
2013, but less obviously in 2014. Inter-
est rate levels also play a role in setting
regulators’ allowed return on equity.
As an example, the average ROE was
12.7% for both gas and electric utili-
ties, and this year will be around 10%.
While we don’t expect them to rise
in the near future, the downward pres-
sure from falling interest rates over
the last 30 years will almost certainly
be less of a factor going forward.
A growing economy is good for
utilities, but due to the relatively inelas-
tic nature of demand, capital-spending
programs that grow the rate base will
have a greater impact on earning pow-
er growth. Utilities are also benefiting
from growing U.S. energy production
and low-cost natural gas relative to the
rest of the world. Many customers are
switching to natural gas for
heating, and we are seeing
industry line up to take ad-
vantage of our global com-
Regulation is a key con-
sideration when investing
in utilities. One of the most
noteworthy proposed regu-
lations came this summer when the
U.S. EPA revealed rules to reduce
greenhouse gas emissions from exist-
ing power plants by 2030 by 30% vs.
2005 levels, along with interim goals
in 2020. This would add to the grow-
ing list of planned coal-fired power
plants facing retirement, as the coun-
try transitions to more gas-fired and
renewable generation for electricity.
Which electric utility sectors do
you favor and why?
Kohli: We continue to prefer the long-term fundamentals of regulated utilities,
believing that relatively high levels of