10% Return On Equity Seen For Utilities Space By Senior Equity Analyst
July 20, 2010 - The Wall Street Transcript has just published Alternative Energy and Utilities Report offering a timely review of the Utilities sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Travis Miller is a Senior Equity Analyst for Morningstar, Inc., where he covers domestic and international utilities, and independent power producers. Prior to joining Morningstar in 2007, Mr. Miller worked as a reporter at several Chicago-area newspapers, including the Daily Herald, Arlington Heights, Ill. He holds a bachelor's degree in journalism from Northwestern University's Medill School of Journalism and an MBA from the University of Chicago Booth School of Business, with concentrations in accounting and finance.
TWST: As you look at the space, what are the top one or two issues facing utility companies at the moment?
Mr. Miller: The number one issue right now that we're watching closely is the demand outlook - not so much even 2010 demand, but looking out to 2012 and even 2013, what is the normalized environment going to be for power demand and natural gas demand? Demand affects both sides of the utility industry. It affects both the regulated side and the more volatile merchant power generation side. So we are watching demand and then the follow-on effect for power prices, natural gas prices and other commodity prices.
TWST: At this point, what do you think demand will look like?
Mr. Miller: We saw the substantial drop-off in industrial demand during the last two years. That's the big factor in terms of thinking about normalized demand, and that's obviously closely tied to the economy. As industrial production numbers fell, so did industrial electricity use in the U.S. And as the economy rebounds, we expect industrial demand to come back. Since industrial demand is 25% to 30% of total usage, a 10% or so rebound from lows we saw last year should have a substantial impact on reversing the declines we've seen in total usage.
TWST: With this weak demand, how has the industry reacted or adjusted to what's going on here?
Mr. Miller: We've seen many utilities over the last year and half go into cost-conservation mode, trying to become more efficient, trying to cut redundant costs, become better at serving customers in a more cost-effective manner. That's been the big trend, addressing those costs so that top-line declines from weak demand don't mean similar bottom-line declines. Some utilities have done a good job of that, some are still working on it.
TWST: Where do we go from here? Do things gradually get better or is it more of a V-shaped recovery for the industry?
Mr. Miller: As the U.S. economy goes, so goes the utility industry for the most part. Depending on your outlook for the economy, there should be a very strong correlation to how the utility industry performs coming out of this recession. We think we are in the midst of an economic recovery. We don't believe in the double-dip recession, and we think by 2012 or 2013, most utilities will be back to a normalized earnings environment.
TWST: How do you define normalized? What kind of growth?
Mr. Miller: We generally think about an historic 1.5% to 2% usage growth and typical inflation-like asset growth, leading to 4% to 5% normalized earnings growth across the industry.
TWST: Would the industry prosper under that?
Mr. Miller: Yes, I think so. We've seen that during the last decade since the deregulation movement and the resulting fallout. If we get back to an environment where a fully regulated utility can yield in the 4% to 5% range and put up 4% to 5% earnings growth, investors should be able to earn a 10% return on equity, which we think is reasonable for most utilities.
TWST: Let's look beyond the economy, in which none of us predicted any great veracity here. How is the industry adjusting to all of these changed demands, be it environmental or clean energy?
Mr. Miller: Once we get back to this normalized economic environment, certainly the actual environment is going to become a much bigger issue for most utilities. Everyone who's followed utilities and the environmental debate knows that utilities are one of the largest producers of carbon emissions in the country. With worldwide discussions going on about global warming, utilities are one of the key targets for environmental restrictions. That's going to have a significant cost that ultimately will be borne both by the consumer and in many cases by the utilities and their shareholders. The impact of environmental legislation in the U.S. is really unknown at this point because there are many ways to distribute those costs. In some cases, the consumer might bear 100% of those costs; in other cases, the utilities would bear more of the costs. But no doubt, anything that we do to constrain carbon emissions and other pollutants will raise energy costs.
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