In Focus

With Rolling Blackouts, Are Utilities Still Rolling In Profits?

I'm not sure if this would classify as "buying what ya know" since I'm sort of clueless when it comes to the companies, but as a Chick living in California, electricity is a subject we see daily on our local newscasts. My family is fortunate to be living in an area under the jurisdiction of the Department of Water & Power, thus free from blackouts. For other Californians, however, the energy crunch is, quite simply, a serious drag. Many are left in periodic darkness without even a moment's notice. The whole situation has me perplexed. It just seems so archaic. Did we not learn anything from the energy crisis of the 70s? Granted, some of you out-of-staters may be laughing at California's forced candlelight, soup-in-a-can vigils, but I think we all can relate to the tears we shed over our gas and electric bills! I have completely turned into my parents -- running around the house turning off every light as quickly as my toddlers can reach up on their tippy toes to turn them on. Well, for every ying, there is a yang, right? I mean, if we're pouring out all this money, someone must be raking it all in! Tweaking my beak a bit, I decided to investigate.

Looking into my own state, I found nothing but a couple of dim bulbs: Pacific Gas & Electric (NYSE: PCG) just filed Chapter 11 last week and Southern California Edison (NYSE: EIX) is struggling not to follow suit. Well, those are two companies I'm glad I'm not paying my hard-earned cash to, nor giving any investment dollars. Beyond our borders, however, things are looking a little brighter. Most U.S. utility companies are actually looking forward to strong first-quarter results, due to increased demand for heat and electricity because of the cold weather we have all endured. In fact, market research firm First Call/Thomson Financial says while estimates suggest earnings of the S&P500 as a whole will fall by 8.6% for the first quarter, it expects utility profits to grow 11%! Wow. There's actually an industry out there that's not cutting their earnings estimate or warning of lowered profits? Quite the contrary, analysts expect utility earnings to outshine the overall market into 2002.

Back up. A mere two years ago, the electric utilities were the worst-performing group of the Standard & Poor's SuperComposite 1500's worst-performing sector. Basically, they were the bottom of the bottom! I guess you could say what comes around, sure does go around! Isn't it stock guru, Peter Lynch, who told us to bottom-fish, finding value in stocks that are out-of-favor? Shoulda listened.

Let me back up even more. I thought utilities were something for risk averse or retired people. Don't mean to stereotype, but that's just the impression I had. What happened? Deregulation, that's what. In the mid-90s, much of the electric utility industry followed the lead of the telecommunications industry and competition ensued. Profit margins are now in the hands of the marketplace instead of state utility commissions. Power is a commodity that can be bought and sold to the highest bidder. One of the reasons California has had such problems is because "price caps" were instituted, making them less competitive in the open market. Suddenly, when we needed extra power from outside sources, those sources had already sold their allotments to higher bidders. That's definitely a simplification, but hey, I'm a Chick, that's what I do!

The companies that seem to have benefited the most are those that have the extra power to sell in the wholesale markets. Consider Dynegy, Inc. (NYSE: DYN) and Enron Corp. (NYSE: ENE): both have seen their revenues surge. I decided to look at their financial statements and discovered these companies have some pretty thin profit margins. In other words, their "cost of goods sold" is almost as high as what they make in sales! Hmm, not very Chicky. As a consumer, we'd better hope there's not too much icing on their cake. After all, utilities are something we all need, pay for, and would have a hard time doing without. Of course, as investors, that does rate them pretty high on the "repeat profitability" Chick criterion! I also discovered the companies don't like to keep a lot of cash on hand. Their "cash vs. long term debt" ratio is nowhere near our Chicky standards. Maybe this is what made those California utilities so vulnerable. Obviously, deregulation has had its share of bugs to work out, but these cash-strapped companies may not have the assets to weather the storm.

By no means am I trying to turn any investors away from adding a utility stock to his or her portfolio. This is a sector of the industry that is clearly on the upswing. No one can shake a finger at a company boasting strong quarterly earnings results. Profits are profits. As we continue to look for new sources of energy, this industry will undergo many changes, in addition to those created by deregulation. Still, even if the electric utility companies could make it through the Chicks' Dozen, I'm just not sure if the Chicks' portfolio is ready for a stock within an industry going through so much turmoil.

By the way, my state may not be so hot at producing power, but we sure do produce some terrific wine and great movies... which we can always enjoy in the dark!