March 20, 2020

Breakingviews: More regulation, less return for U.S. utilities

by Breakingviews.

A traditionally defensive sector for U.S. investors is looking less so. Power companies will need to keep producing even as the Covid-19 pandemic causes other industries and locales to shut down. And while customers will be less able to pay their bills if unemployment spikes, the need for investment will persist. PG&E’s return from bankruptcy illustrates this dilemma.

A sharp rise in joblessness is coming. An NPR/Marist poll last week reported 18% of households already had one laid off member. That is likely to have two effects on power suppliers: bills going unpaid, and regulators not allowing price hikes.

Already, utilities were finding things harder. The average allowed return on equity for electric utilities has fallen from over 12% in 1990 to below 10% in 2014, according to S&P Global, and it’s still declining. And while regulated returns create a cap, they don’t provide a floor on what companies will actually make.

That may partly explain why the Dow Jones Utility Average Index is down 17% since the start of the year. That’s better than the S&P 500 Index, which is down roughly 25%, but it hardly constitutes a defensive performance.

While the lights don’t go out in a recession, utilities’ revenue can fall. In 2009, PG&E – the nation’s largest power supplier – reported an 8% decline on the year before. Rivals saw similar falls. Most big companies, such as Duke Energy, took two years to get back to 2008’s earnings level. It took PG&E six years. Low rates make things tougher, as regulators tend to reduce the authorized return.

PG&E’s exit from bankruptcy puts it in the crosshairs. The $2.4 billion it thinks it can earn by 2024 is equivalent to around a 12% return on its common equity. That’s because the company’s market capitalization is around $4 billion, and existing investors will own about one-fifth of the total equity in the restructured business. In normal times, that would sound pretty good.

As it is, those aspirations look optimistic. PG&E and its rivals face struggling customers, low rates, edgy regulators and an undiminished need for grid investment. PG&E’s role in numerous Californian wildfires mean its popularity will take longer to rebuild than its balance sheet. No wonder investors aren’t seeing the sector’s defensive qualities.

_____________________________________________________________________

Request a free trial of Breakingviews here

Article Topics

Get In Touch

Subscribe

We have updated our Privacy Statement. Before you continue, please read our new Privacy Statement and familiarize yourself with the terms.×