American utilities remain unattractive after a combination of disastrous overseas ventures and colla...
American utilities remain unattractive after a combination of disastrous overseas ventures and collapsing wholesale electricity prices have de-rated the sector.
Normally viewed as a more defensive area of the market, the S&P 500 Electricity Index has fallen by 29.08% over the calendar year to 8 October, compared to a 30.45% drop in the broader S&P 500.
Stock selection has been crucial to playing utilities this year, with only four of the 24 stocks that make up the sub-index posting positive returns, while seven stocks have more than halved in value over the same time.
Rob Marshall-Lee, global industry analyst at Newton Investment Management, says a number of stock-specific and structural problems have been the main driver behind the sector's heavy losses over the year to date.
He says: 'The collapse of Enron has taken away any liquidity in the forward market and the credit agencies are really clamping down on the sector. Anything with a merchant side to it is seen as very opaque and there have been reams of downgrades where companies' trading positions are not transparent.'
Moreover, with the power market in decline price-wise, the downgrading of a number of utilities' corporate debt by the ratings agencies has sent more heavily geared companies into a downward spiral. After missing Enron, the agencies are now clamping down heavily and at times overreacting to any negative newsflow.
James McLellan, US fund manager at Insight Investment, agrees the ratings agencies have been feeding the nervousness surrounding the sector.
Moreover, these domestic problems of illiquidity in the power markets, downgrades and poor investor sentiment have been exacerbated for a number of companies in the sector by loss-making forays into overseas markets, particularly the heavily deregulated UK market.
McLellan notes the sector is typically a low growth area where organic growth can be difficult. As such, overseas ventures are one of few ways to grow sales without resorting to acquisitive strategies.
'A number of US power companies have gone overseas, such as TXU Energy, and it has generally been a loss leader impacting results badly. A lot of US utilities are now operating in the UK market, but the weakness in the power markets has led a number to retrench these operations,' McLellan adds. TXU, down 63.556% over the year to 8 October, is a classic example of the sector's recent failings. Although its vertically integrated business model remains robust and risk averse in its base of Texas, moving in to the UK at the top of the market has proven disastrous, says Marshall-Lee.
'TXU made the mistake of contracting out power output and wholesale prices in the UK have since fallen by over 30%. It is locked into the contract and has had to take large write-offs, which has not helped investment sentiment,' Marshall-Lee says.
Valuations becoming more attractive.
Large potential upside in medium term.
Approach of winter ups fuel usage.
Power prices remain depressed.
Overseas exposure is damaging.
Investor sentiment still poor.
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