Friday, November 07, 2008
By Rick Roop, VP and Portfolio Manager With President-elect Obama having been ahead in the polls for many months, we have been digging into his statements on his proposed energy policies trying to figure “what’s next” particularly in the area of the electric generating industry. This industry has been in a state of confusion ever since it became clear Obama would likely be the next president because of the great differences between his public statements on the environment and reliance on alternative energy and the policies of the Bush Administration. This confusion has left a big question mark in the minds of many in the utility industry as to where to invest capital for the next generation of electricity producing assets. According to the most recent Annual Energy Outlook from the Department of Energy’s Energy Information Administration (EIA) electricity demand from 2006 to 2030 is expected to increase 25%, using the middle forecast; 30% if you go with the upper forecast. However, nowhere in the report is there a weighting for the additional load required from the use of electric cars by U. S. citizens between now and year 2030. According to the Obama/Biden New Energy for America Plan, a goal is to place at least 1 million Plug-in Hybrid cars on the streets of America by 2015. The production of electricity is a highly capital-intensive business. New power plants, transmission lines or gas pipelines are not only very expensive but they take years to build. With the recent crisis in the financial markets, financing has become more difficult and expensive, adding more risk to any utility wishing to add additional capacity. Add to that the 5 to 7 years it takes to permit and build a coal fired or nuclear plant, and you have just layered on additional risk to process. Our research at DCM has led us to choose utilities that in the short term (3 to 5 years) appear to have low risks in the areas of finance, regulatory environment, and industry concentration as we wait for a concrete Obama plan to come into view. One such company in our opinion that meets this risk profile and yet offers solid growth potential is Southern Company (SO). For over 25 years through my work with the International Society for Automation, I have been privileged to get to know a wide range of SO’s managers. I believe they are among the most “heads up” of all electric utility management teams in the nation. Southern Company is a good fit for our clients at DCM because of management’s ability to minimize their risk profile without limiting opportunities for growth. This has been accomplished by successfully maintaining 85% of their business under the protection of the regulated utility umbrella, while building a competitive wholesale business outside the regulated service territory. Southern company has leveraged their ability to generate good profits under their protected territory by maintaining a very cooperative relationship with regulators. As a further hedge against risk, it has been Southern Company’s policy to insist on fixed long-term energy contracts for capacity added outside their protected territory. Going forward we believe that any utility with fossil fired power plants will come under much tighter clean air regulations, which will in the end drive costs up for the end consumer. New clean air compliance equipment will raise the cost of production for all coal fired power plants. As a result, any utility that can avoid or diminish these costly capital additions will increase their profit margins. Southern Company will benefit in this regard because they are already 15% nuclear and have applications in place to increase that level. Southern is a rare utility in many ways. They have maintained an A debt rating, which makes their cost of capital lower than many companies in the industry. They serve a part of the country that is experiencing population growth, thus, they are growing faster than many utilities. They have a long-term track record of increasing their dividend. With a current dividend yield of 4.9% and prospects for dividend growth in the 4% range, SO offers a generous potential return from a high quality company that sells a product we can’t live without. We own the stock. This blog is for information only. Please consult your own financial advisor about SO.