# Shockingly Low P/B Values: Adjusting Electric Utility Book Values

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Includes: D, DUK, DYN, ETR, EXC, KEP, NEE, NRG, SO
by: Value Research

Several electric utility companies including Dynegy Inc. (NYSE:DYN), Korea Electric Power Corp. (NYSE:KEP), and GenOn Energy (NYSE:GEN) appear on my screens as low P/B investments. Are they truly cheap? Can I really make an apples-to-apples comparison of their book values of their net assets?

Rather than trust stated asset book values, we can regress book value of property, plant and equipment (PP&E) and related long-term asset accounts against their power generation in Megawatts. This is just a fancy way of saying we are going to plot the accounting values and output of the long-term assets of the firm and draw a line through the plot. Assets with accounting values above the line are rich and assets with accounting values below the line are cheap.

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An R-squared value of 0.8593 is a very good fit for economic data. We can also try to adjust for the useful life of the PP&E by summing future years of power generation, discounted at a reasonable rate, say 7%:

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So itâ€™s probably better to stick with the first, simpler model which gave a better fit.

I can use this model to adjust the book value of equity for each company, and compute an adjusted P/B ratio that equates prices on a per-megawatt generation basis. I also strip out intangibles assets and goodwill:

 Ticker Market Cap (\$millions) BV Equity (\$1000s) Goodwill + Intangible Assets (\$1000s) Model PP&E Adjustment (\$1000s) Adjusted BV Equity (\$1000s) Original P/B Ratio Adjusted P/B Ratio KEP 7,230 36,142,000 402,000 62,248,739 28,467,739 0.20 0.25 DYN 667 2,671,000 129,000 7,406,814 3,733,814 0.25 0.18 GEN 2,890 5,524,000 136,000 20,071,355 19,167,355 0.52 0.15 NRG 5,700 7,353,000 3,549,000 20,067,237 17,493,237 0.78 0.33 ETR 11,580 8,590,400 377,172 25,632,880 9,739,906 1.35 1.19 PGN 13,700 9,954,000 3,655,000 17,395,110 1,799,110 1.38 7.61 NEE 22,800 14,599,000 - 39,019,257 13,681,257 1.56 1.67 SO 33,600 16,465,000 - 37,989,535 10,789,535 2.04 3.11 EXC 28,850 14,025,000 2,625,000 21,121,671 1,665,671 2.06 17.32 D 28,020 11,686,000 3,141,000 23,176,995 4,639,995 2.40 6.04
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There are many caveats to this approach. First, determinants of value include the threat of bankruptcy, which is perceived as being higher for GEN and DYN. Second, different costs are associated with older, less efficient plants and different energy sources. Third, these adjusted book values are based on accounting conventions which might distort economic realities, and ignore the economic value of intangible assets or assets that donâ€™t produce electricity. Finally, electricity is sold in different regions at different prices. All of these factors can be used to account for different values of different plants.

That being said, this analysis supports an assessment that KEP is cheap based on the value of its net assets. Unfortunately, it is a state-run enterprise, so an investment in KEP is a play on the South Korean government allowing KEP to raise rates to levels sufficient for profitability. This may be a stretch in a difficult economy.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KEP, GEN, DYN over the next 72 hours.