The Wall Street Transcript recently interviewed Marc De Croisset, US Utilities Vice President and a Senior Analyst at Macquarie Capital (USA) Inc. Key excerpts, including his outlook for regulated electric utilities, follow:
TWST: As we look at that space, what's of prime import at this point? What's going on that investors are really focused on?
Mr. De Croisset: Back in November and December of last year investors were focused heavily on regulated electric utilities. This was the flight to safety group and it outperformed the S&P by roughly 20%. Year to date, the regulated group has been lagging behind higher beta names as investors chase performance. This has weighed on our space. In addition, several concerns have surfaced. Regulated utilities have been impacted by the slowing economy (GDP and electricity usage are highly correlated), by regulatory pushback and by the deferral of capital plans. All this tends to slow earnings growth. On the valuation front, multiples for regulated names have also been depressed in our opinion by high credit spreads and high Baa bond yields.
TWST: What are you telling investors to do?
Mr. De Croisset: We're cautious. We believe that this is a bear market rally and we're recommending that investors get into regulated utilities ahead of the first quarter and return to higher beta names selectively as opportunities present themselves. An eventual movement toward higher beta stocks is not at all irrational, by the way. We are cognizant of this. If this recession plays out like the prior ones, it will be the right thing to do. After all, this recession is 15 months old now. The recessions of 1981-1982 and 1973-1975 lasted 16 months. So the timing looks and feels about right from that perspective, but our concern is that credit markets just aren't open to the extent they need to be for a full recovery. If first quarter results are poor, this bear market rally could correct.
TWST: So don't get trapped.
Mr. De Croisset: Don't get trapped.
TWST: Who is at the top of your favorite list at this point?
Mr. De Croisset: From a tactical perspective, I like PG&E (PCG) and Progress Energy (PGN). I believe that they will not disappoint in the quarter, so they are prudent picks. For longer-term holders, I like Teco (TE), which will have a very tough quarter in terms of the performance of its coal business. That could represent an interesting buying opportunity. Teco is based out of Florida and just received a favorable rate case order. Portland General Electric (POR) is an Oregon-based utility that is trading well below book value and looks interesting to us.
TWST: What is going on there that has investors so wary?
Mr. De Croisset: It's a puzzle to me. There is some litigation overhang, which we think has more bark than bite. There is some volatility in the earnings stream due to the structure of the fuel recovery mechanism. The utility is also regionally focused. This may scare some people away as it leaves POR in a no man's land of investor risk appetite. We view this as an opportunity and not a liability. POR just got left behind.
TWST: So that provides some interesting appeal.
Mr. De Croisset: It does. And POR issued equity in the first quarter. We don't expect another equity issuance for some time. The rate base growth of that story is very significant, and I'm hard pressed to understand why it's trading at such a deep discount to book value.
TWST: Are there any names to be wary of that are not in favorable rate situations or are falling behind?
Mr. De Croisset: FirstEnergy (FE) is an Ohio-based utility that has sold off significantly but there is a risk that consensus earnings are too high. They could ratchet down in May, leading to pressure on the stock despite its current valuation.
TWST: So that's one to be cautious about.
Mr. De Croisset: It's one to be cautious about. Stock reactions are always very difficult to forecast, but I think the consensus numbers are high and could come down. A knee-jerk reaction could take place.