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.


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