Do electric utilities understand how to earn profits for shareholders in a competitive market?
Here's one way to look at the problem. Gather a group of financial experts and ask this question: If a company's long-term bonds are rated AA, and yield 8 percent, what minimum return would you require from dividend yield and price appreciation to induce you to buy that company's stock?
The typical expert will say 12 percent, indicating a 4-percent premium (or spread) above AA bond yields. This figure approximates the rates of return on common equity (about 3.4 percent above yields on AA-rated bonds) that regulators have allowed for electric utilities from 1986 to 1996, as compiled by Regulatory Research Associates. For companies with lower-rated debt, the spread would obviously be higher.
Today, with the advent of competition, the dam has burst. With the grass looking greener on the other side of the fence, utility managers are considering expansion. Some companies are sending other products over their existing lines and adding special related services. Others are concentrating on generation and power contracting. Still, companies can see more by spreading their wings with large investments in foreign utilities. All are caught up in a compelling rush to grow.
Unfortunately, the grass may not be any greener.
From 1981 to 1993, returns on common book value for unregulated businesses hovered at 4 percent above AA-rated bond rates, based on the
Standard & Poor's index of 400 industrial common stocks. (Since 1995, the spread has climbed above 12 percent, however.)
Utility diversification strategies are nothing new. In the not-so-recent past, utilities got into everything from