The Wall Street Transcript recently interviewed Christopher R. Ellinghaus, Senior Vice President of Institutional Research at Shields & Company responsible for coverage of the electric and gas utilities, diversified natural gas, and electric generation industries. Key excerpts follow:
TWST: Chris, has the utilities space proven to be a good hideout in this market turmoil that we're going through?
Mr. Ellinghaus: Unfortunately, there has been no such thing as a hideout, but we have done relatively better than most things and there are a few stocks within the group that have done even better than the group of utilities. There've been a few places to hide out, nothing that you would call safe, but you certainly didn't lose as much in some of the most stable utilities that you might have lost in some financials — by a long shot.
TWST: Why have they been hit too? Is this not a very stable, long-term business?
Mr. Ellinghaus: Yes, I think that's why we have outperformed, but we haven't outperformed by as much as I would have thought in this environment. There hasn't been quite the recognition of safety that you might have expected to find in this market, but I think there's some recognition. It's a pretty narrow margin really and I haven't calculated it for today, but I'm guessing that based on today, we're gaining a bit more on the market as well.
TWST: Who would be at the top of your names to look at?
Mr. Ellinghaus: Allegheny (AYE) has had a pretty steep discount to what I think the five-year upside is. When I look at my industry list here, it is one of the most deeply discounted names that I can find.
Mr. Ellinghaus: It is a utility, but it has a commodity based upside story to it. To the extent that the economy falters and power prices are likely to come down, people are just avoiding utilities that have commodity sensitivity, and so it's sort of a throw the baby out with the bath water kind of question. It won't affect Allegheny in the near term, but they are worried about what the ultimate upside might be in four years when they come off of their fixed rates in Pennsylvania, and apparently that has caused everybody to avoid those types of stocks.
Another one, FirstEnergy (NYSE:FE), and the other companies that have significant amounts of their earnings coming from the non-regulated energy side, have been particularly pounded along with the independent power producers.
TWST: Is that rational or does it just depend on the market?
Mr. Ellinghaus: It's rational to a point. Lower power prices over the next couple of years do not have a great effect on Allegheny's earnings over the near term; in fact, if coal prices come down along with the rest of the commodities, there could be a positive and a negative impact. But for the companies that are coming off of fixed tariffs, particularly in Pennsylvania and Ohio, that have upside to those tariffs going to market in 12-24 months, there is a certain forecast for power, and that forecast has got to come down next year as the demand shrinks and the economy is likely in a recession. This does not mean it is going to impact Allegheny in the near term, but it makes it more difficult to predict what the 2012 power price might look like and see what the eventual upside is. It is trading for about 6 times my 2010 estimate, which I think is still pretty good at this point, but it might need to come in a bit. There is a lot of room when you are at only 6 times forward earnings. So that's pretty extreme.
TWST: What's it going to take to get these stocks moving?
Mr. Ellinghaus: There has got to be an opening of the credit market, before the market can go up. And we have got to get some earnings out to see that they are still pretty stable compared to the rest of the economy's earnings. Those two things would go a long way. I think we could get some bad news on the capital front over the next three or four months, which would imply some slowing down of growth rates. But I don't see a lot of really bad news ahead for the utilities and when you compare this industry economically to other interest sensitive areas like the financials, we are going to look pretty attractive compared to much of the S&P 500. So I am pretty encouraged. And I think we are starting to see some improvement in the credit markets, but we have got a long way to go before these stocks can truly start to see reasonable long-term valuations.