utilities | sector analysis nihar shah michael song 02.23.2010

Utilities | Sector Analysis

Nihar ShahMichael Song

02.23.2010

Recommendation

• Decrease weight in SIM portfolio by 72 bps

• Final: Underweight 150 bps

Introduction

• Utilities Sector– Size: 1721.2B– Industries

Industry Market Cap P/E ROE % Div. Yield % Price to Book

Diversified Utilities 135.0B 11.5 13.00% 4.69% 1.84

Electric Utilities 301.6B 15.1 10.00% 3.95% 1.81

Foreign Utilities 1170.9B 86.0 1.60% 1.58% 1.98

Gas Utilities 104.3B 15.7 13.80% 3.99% 3.31

Water Utilities 9.5B 0.0 -5.20% 3.47% 1.75

Source: Yahoo Finance as of 2/23/10

Largest Companies in (SPUT)

Company Market Cap Sales (in M) EPS 5 Yr Growth LT Growth ROE Yield ROE + Yield

SPUT 355.0 B N/A N/A 8.00% 5.00% 12.30% 4.60% 16.90%

EXC 29.5 B 17.32 B 4.09 10.00% 0.00% 22.90% 4.70% 27.60%

SO 25.9 B 15.74 B 2.07 3.00% 4.00% 13.00% 5.40% 18.40%

NGG 24.7 B 24.13 B 3.85 2.00% 7.00% 25.20% 4.60% 32.90%

DUK 21.40 B 12.73 B .83 -8.00% 4.00% 7.40% 5.80% 13.20%

FPL 19.40 B 15.65 B 3.97 12.00% 7.00% 13.60% 4.30% 17.90%

AEP 16.10 B 13.44 B 2.88 5.00% 4.00% 12.00% 4.90% 16.90%

FE 12.10 B 12.97 B 3.29 11.00% 3.00% 13.60% 5.50% 19.10%

EIX 11.00 B 12.54 B 2.59 10.00% 3.00% 11.30% 3.70% 15.00%

OKE 4.60 B 10.23 B 2.65 3.00% 10.00% 14.40% 4.00% 18.40%

S&P/SIM Weight

(.78)%

S&P/Sector Performance (YTD)

Outperform

Business Analysis

Electric

Water GasForeignDiversified

Utilities – Catalysts/Risks

• Catalysts– Rate Regulation Increase– Weather Patterns– Improvement in Economy– Green Policy (Nuclear/Water)

• Risks– Rate Regulation Neutral/Decrease– Inconsistent or over-demand– Commodity Prices– Green Policy (Electric/Diversified/Gas)

Industry vs Sector Performance

Sector vs S&P Performance

Historical Prices

0

50

100

150

200

250

Jan-00

May-00

Sep-00

Jan-01

May-01

Sep-01

Jan-02

May-02

Sep-02

Jan-03

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

May-05

Sep-05

Jan-06

May-06

Sep-06

Jan-07

May-07

Sep-07

Jan-08

May-08

Sep-08

Jan-09

May-09

Sep-09

Jan-10

Sector S&P

Correlation: 80.93%

Outperform Outperform

Economic Analysis

Economic AnalysisUnemployment vs GDP

12,200

12,400

12,600

12,800

13,000

13,200

13,400

13,600

Jan-04 May-05 Oct-06 Feb-08 Jul-09 Nov-10

GD

P

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Une

mpl

oym

ent

Real Gross Domestic Product Unemployment Rate

Economic Analysis

Change in GDP vs Sector Price

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

Aug-87 May-90 Jan-93 Oct-95 Jul-98 Apr-01 Jan-04 Oct-06 Jul-09 Apr-12

% C

hang

e in

GD

P

-30

-20

-10

0

10

20

30

40

% C

hang

e in

Sec

tor

Real Gross Domestic Product EXC.S

Forecast: GDP will very slowly increase over the short term

Economic AnalysisRelative Strength of Utility Sector vs S&P 500

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Aug-87 May-90 Jan-93 Oct-95 Jul-98 Apr-01 Jan-04 Oct-06 Jul-09 Apr-12

S&P 500 Rel Str

Economic Analysis

Forecast: Interest Rate will increase in the short term

Economic Analysis

EXC.S vs OIL (USO)

R2 = 0.4733

0

20

40

60

80

100

120

100 120 140 160 180 200 220 240

Utility Sector Price (EXC.S)

Oil

ETF

Pric

e (U

SO)

Economic Analysis

Economic Analysis

EXC.S vs Natural Gas (UNG)

R2 = 0.7701

010203040506070

100 120 140 160 180 200 220 240

Utility Sector Price (EXC.S)

Nat

ural

Gas

ETF

Pri

ce

(UN

G)

Forecast: Natural Gas Price will stay relatively constant in the short term

Economic Analysis

EXC.S vs Coal (KOL)

R2 = 0.7565

010203040506070

100 120 140 160 180 200 220

Utility Sector Price (EXC.S)

Coal

EFT

Pri

ce (K

OL)

Economic Analysis

Forecast: Potential for long term growth

Regulation• State commissions are responsible for determining utilities’ proper rate bases and allowable

operating expenses. Individual states’ rulings often differ with regard to these determinations. They also differ in allowed accounting treatments for depreciation accruals and investment tax credits. Although rulings are often presumed to be based solely on the public interest, commissions actually seek to provide a balance between investor and consumer interests.

Green Policy (Update)• On June 26, 2009, the House of Representatives passed, by a

narrow 217–205 margin, its version of a new energy bill, H.R. 2454. Included in the bill, called the American Clean Energy and Security Act, 2005–2050, were provisions for a cap-and-trade system that would incrementally reduce GHG emissions, beginning with a cap on 2012 emissions that is 3% below 2005 levels. The bill, whose principal sponsor was Henry Waxman (D.–California), also included a requirement that utilities get 15% of their electricity from renewable energy sources and, through increasing their energy efficiencies, reduce their electricity use 5% by 2020. Individual states, however, would be allowed to vary these two percentages as long as the total came to 20%.

Financial Analysis

Sector

Financial Analysis

Margins

Net ProfitN/A

Summary

Analysis Conclusions View

Business Mature industry, cyclical in nature Neutral

Economic Expect slow growth Slightly Negative

Financial Declining Revenue, stable profit margin stable ROE, and declining Net Profit Margin.

Negative

Valuation Sector seems to be trading at a slight discount.

Slightly positive

Overall: Slightly negative for short term

Recommendation

• Decrease weight in SIM portfolio by 72 bps

• Final: Underweight 150 bps

Questions