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Several electric utility companies including Dynegy Inc. (NYSE:DYN), Korea Electric Power Corp. (NYSE:KEP), and GenOn Energy (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.

click to enlarge

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%:

PP&E Book Value vs. PV Generating Capacity

So it’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

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 don’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.

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