Falling Dividends: Are Utilities Next?

It's no secret, many companies are looking to strengthen their balance sheet and conserve cash. Most companies have been reluctant to cut their dividend payouts but recently, many have folded to the pressure and have cut severely.

With AAA companies slashing their payouts (GE), safe and reliable dividends have become scarce. Long known to be a steady source of dividends, the utilities have recently run into a myriad of troubles, causing some to doubt their previously rock solid high-yields.

Some utility companies have recently lowered their dividends including Constellation Energy (CEG), Ameren (AEE), and Great Plains Energy (GXP). A troubling thing is that many of the reasons for these cuts aren't company specific. Deteriorating demand and a tough credit market will inevitably affect even the strongest firms.

In most markets, companies can raise prices to offset higher costs. In the utility sector however, most firms need to get the government's permission to change rates because of their monopolistic nature. Because consumers have already been hit hard by the recession, regulators may be less merciful towards utilities. As we have seen in numerous other companies this year, these problems can result in credit downgrades, which makes it even harder to obtain new financing.

The 'double threat' of slacking consumer demand and a tricky credit market is more damaging to the utility sector than to most others. In the past few years, utilities have been on a growth spurt expanding fervently and taking on many new projects such as new power plants. These projects are tough to abandon because most companies have already poured millions into them and a half-built power plant is worthless.

Companies in Danger

Morningstar has listed four companies that they believe have their dividend payouts on the chopping block. They include:

• Pinnacle West (PNW)
• Hawaiian Electric (HE)
• PNM Resources (PNM)
• NiSource (NI)

Well-Positioned Companies

Morningstar has also listed their top four picks that they believe can maintain their payments. The list includes:

• NSTAR (NST)
• Southern (SO)
• Westar Energy (WR)
• Northeast Utilities (NU)

Comments

[Ryan Vanzo:]

Questions and comments welcome.

Mar 10 11:02 AM

[jack kreg:]

will cap and trade taxes on power generation be a positive or negative on Utility profits and cash flow, hence dividends, and there growth or stability over the next few years, when Obama puts Billions of dollars of taxes on the utility's?
I appreciate your opinion, thanks!

Mar 10 12:28 PM

[William H J...:]

cap and trade won't put $billions of taxes on the utilities because the utils will just push it off on to the consumer in the form of higher rates. -- cap and trade will effectively raise all individuals' taxes. "I will not raise taxes 95% of you!" -- yeah right.

Mar 10 02:44 PM

[User 283977:]

The utilities are going to need cash since busines has to be down... expect dividend cuts with decreasing stock prices.

Mar 10 03:16 PM

[Victor84:]

Some of these utilities recorded enormous capex costs. When credit was good, this was not a problem. Falling demand obviously hurts revenue generation as well. Some of these companies might have to cut back.

That being said, the margins stay the same and having a monopoly on an essential services guarantees a relatively stable earnings forecast.

I particularly like water utilities.

Mar 10 03:22 PM

[Ryan Vanzo:]

Thanks for all the comments.

Jack Kreg- I believe that the caps and taxes forced upon the utilities will end up having a detrimental impact on utilities but not as much as you would think for the consumers. Because almost all utility companies are already heavily regulated, in the short run, they may have problems pushing on these costs to the consumer, as all price hikes have to be presented and approved by regulators. I think in the long-run, these costs will eventually be transferred to the consumer, therefore defeating the purpose of the tax changes. If you would like anything more specific just post another question or two and I would be glad to go into further detail.

William H Jones- If you knew anything about the industry, you would know they differ greatly than most. All price hikes, as I said before, need to be approved by regulators. These regulators will be very reluctant to let them raise prices in the short term, as consumers are feeling pinched. This will cause utilities to operate at the break even point in the short term. In the long run you are correct though. It may take many years though for these costs to shift to the consumer, but by the the laws may have changed anyway.

User 283977- Naturally, after this article, I agree.

Victor84- I agree with you except for your margins statement. Their margins will be hurt if new taxes and caps are levied on them because of their inability to transfer these costs immediately to the consumer. That's what happens when you run a monopolistic competitive firm though.

Mar 10 06:49 PM

[DarkStealth:]

Cap & trade will benefit utilities in proportion to their carbon intensity from their fuel mix. It should hurt utilities who get most of their power from coal, and benefit ones getting power from renewables. Regulators could simply pass the costs on to consumers (and this happened in the UK - a bunch of utilities raised customer rates to pay for carbon credits but were given the carbon credits for FREE, pocketing billions). However, that would appear to be a tax increase to ratepayers, which wouldn't be popular during a depression. And the entire point of a cap & trade system is to redirect dollars towards renewable forms of generation, like wind and solar. Companies with deep nuclear portfolios may benefit as well. So companies like FPL and CEG & some California utilities may do quite well, whereas coal-heavy utilities may end up losing a good portion of their profit margin.

Additionally, half the states now have renewable portfolio standards, requiring some percentage of their power to come from renewable sources over some time frame, like a decade. Note this is a _legislative mandate_, not something subject to the whims of companies who decide to cut back on spending by 3% due to a depression, and a national cap & trade system will turn this from a basic requirement for staying in business into a potential for making a profit off of slower utilities. If one utility is mandated to generate 15% of their power from renewables but generates 20%, they can sell that 5% to other utilities, most likely at a significant premium to wholesale electricity. Energy traders & merchant power producers w/ wind, hydro, solar & nuclear plants should get rich here. Puget Sound Energy is selling their renewable power to California utilities today, earning a tidy profit.

This renewables mandate is causing a huge scramble to build wind farms and install solar panels (with some utility scale solar projects proposed that rival nuclear plants in capacity). So the solar manufacturers like SPWRA and FSLR will benefit (especially SunPower - they've got the experience in installing the utility scale projects), as well as wind turbine manufacturers (Vestas, Gamesa, GE's wind division) & their component vendors (BWEN, Trinity). Nuclear plants may expand as well, but the construction time and potential for cost overruns will dampen enthusiasm for nukes. The biggest risk here is the credit market - if the utilities can't get financing, these renewable projects will greatly slow down. But the basic requirement for more renewable power generation isn't going away, and may become significantly more profitable with a cap & trade system.

Mar 11 03:55 AM

[jack kreg:]

why do we need to add, or even worse, mandate increased "renewable" generation capacity, at a time when demand is slumping?

Mar 11 11:08 AM

[jack kreg:]

Ryan, thanks for article and followup comments. JK

Mar 11 11:09 AM

[Ryan Vanzo:]

Jack- I believe most attempts to cap the utilities and push for more green production will be hindered in the short term. Like you said, with slumping demand and a renewal in 'dirty' fuel addictions, I believe that any increase in costs to the consumer will be thwarted. People were only interested in the environment when it was cheaper or close to the same price as traditional fuels. Now that oil and gas have dropped precipitously, I think that most of the more ambitious plans that will hinder utilities growth will fail, or at least be scaled down dramatically.

Mar 11 07:20 PM