Utilities Seek Power In Numbers

8/8/2011


A wave of consolidation is washing over the utility sector. According to Thomson Reuters, by mid-June, U.S. utilities had announced $44 billion in mergers this year, versus $30 billion in all of 2010.

The CEO of Dominion Resources ($48; D) expects utility mergers to continue as companies try to share the costs of building new power plants. Here are three other reasons to believe more consolidation is in store:

Disaster preparedness. Tokyo Electric Power ($6; TKECF) had a stock-market value of about $42 billion before the Japanese nuclear disaster, but is now worth about $9 billion. That type of disaster has utilities frightened. A smaller, weaker company than TEP might have gone bankrupt, and some U.S. utilities already feel the urge to bulk up.

Rising costs. The cost of raw materials used to generate electricity and the supplies needed to build and repair the distribution infrastructure have risen in recent months. Further cost pressures could squeeze utilities' profit margins in coming quarters, encouraging mergers that can yield economies of scale.

Environmental activism. With regulators stepping up pollution-control enforcement and the threat of further emissions restrictions on the horizon, utilities know the costs of compliance will probably keep rising. Some hope that by combining they can eliminate cost overlaps. Those costs hit coal plants harder than most. American Electric Power ($37; AEP), which generates 85% of its power from coal, estimates the new rules could force it to spend up to $8 billion through the end of the decade.

Higher costs are cropping up at an inopportune time. While consumers use more electronic devices than ever, the increasing efficiency of those devices has crimped demand for electricity. Also weighing on demand is a stubbornly sluggish economy, with gross domestic product growing at an annualized rate of 0.5% over the last five years and 1.6% over the last 10, versus 3.6% in the previous decade.

Electricity usage increased at an annualized rate of just 0.5% in the decade ended 2010, up from 2.4% in the 1990s. In such an environment, expect utility executives to seek economies of scale.

Here are some major deals:

Exelon ($44; EXC) said in April it would buy Constellation Energy Group ($38; CEG) for about $8 billion in stock, plus the assumption of about $3 billion in net debt.


In April, AES ($12; AES) said it would pay $4.7 billion in cash to acquire DPL ($30; DPL).


In January, Duke Energy ($19; DUK) said it would issue about $14 billion in stock and assume $12 billion in debt to acquire Progress Energy ($47; PGN).


In October, Northeast Utilities ($34; NU) announced plans to purchase NStar ($44; NST) for $4.7 billion in stock, plus the assumption of more than $2 billion in debt.


In February, FirstEnergy ($44; FE) closed its $8.5 billion purchase of Allegheny Energy.

The table below lists nine utilities that may look attractive to prospective acquirers. Of course, merger possibilities alone do not qualify a stock as a buy, but the potential acquisition kicker makes these companies worth a second look.

UTILITIES WITH TAKEOVER APPEAL
The nine utility stocks listed below may appeal to acquirers. All have enterprise value/EBITDA and price/book ratios near or below the industry average, as well as scores of 49 or higher in our Quadrix Overall, 12-Factor Sector, and Reranked Overall scores. The 12-Factor Sector and Reranked Overall scores rank utility stocks relative to other utilities. All of the listed utilities earn A (above average) or B (average) ratings in our Utility Update, and components of our Top 15 Utilities portfolio are presented in bold.
Quadrix Scores
Company (Price; Ticker)
Market
Cap.
($Bil.)
Enterprise
Value/
EBITDA
Price/
Book
Overall
12-
Factor
Sector
Reranked
Overall
Utility
Update
Ranking
AES ($12; AES)
9.3
5.2
1.4
49
76
66
 B 
Alliant Energy
($39; LNT)
4.3
8.1
1.5
60
80
83
 A 
Avista ($25; AVA)
1.4
7.5
1.2
77
81
96
 A 
Consolidated Edison
($52; ED)
15.3
8.4
1.4
56
50
78
 B 
Duke Energy
($19; DUK)
24.7
9.0
1.1
59
88
89
 A 
Edison International
($37; EIX)
12.1
6.8
1.1
55
88
73
 B 
Entergy ($65; ETR)
11.7
6.9
1.4
78
96
98
 A 
Integrys Energy
($49; TEG)
3.9
7.8
1.3
60
69
86
 B 
NRG Energy
($24; NRG)
5.9
6.1
0.8
70
98
91
 B 
Utility Sector
Average
6.3
8.8
1.6
48
50
50
Note: Quadrix scores are percentile ranks, with 100 the best. 

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