Conrad's Utility Takeovers
05/21/2004 12:00 am EST
"I have one big rule about buying takeover candidates: only buy companies that you wouldn't mind owning even if there weren’t a takeover," says Roger Conrad, the leading authority on utilities. "That way, the takeover is icing on the cake." Here are his takeover bets.
"We have seen a resolution of the California energy crisis and regulatory pressures have been lifted off the industry and the states have begun to raise rates where needed. The second thing that had to happen for utilities to recover was the resolution of the credit crunch. We saw a number of companies declare bankruptcy in 2003, but many more companies were able to roll over debt, or cut their debt. More companies actually had their outlook raised over the last twelve months then lowered and that's a tremendous difference from where we were a year ago. So the credit crunch has definitely eased. There are still some companies that are in a lot of trouble but most of the industries are starting to work their way out. Finally, many of these companies are deleveraging themselves from the basic economy and from the industry cycle. That is really the third building block. To make a long story short, we have the components in place for continued industry recovery from the bust. So the good news if you own good-quality utilities, there is no real reason to run for the hills.
"Meanwhile, I have had a lot of companies that have been my favorites for a period of time, but they have all been trading above what I consider to be a buy price. One favorable consequence of the sell-off is that we are finally coming back to levels that represent long-term value. I think at some point we are going to see a tremendous buying opportunity. I don't think there is any real reason to rush out and buy everything you can get your hands on right now. Nevertheless, I think values are starting to emerge, I think we are getting to the point where it is certainly going to make a lot of sense to make purchases and a lot of things look attractive. In particular, one area we are starting to see long-term values emerge in the utility industry is takeovers and consolidations. What I would like to do is share with you a few companies that I think are very good candidates.
"In the power sector, many utilities are no longer producing power. Rather, they are shipping it over transmission lines and then selling it to the consumer. The companies that are pure ‘wires and pipes’ are a very low-risk businesses. This is a business that lends itself to a sale because the more wires and pipes you can string together, the more you can spread your costs among them whether you are buying elements for building or hiring workers to repair a problem in the case of an emergency. We have seen a lot of mergers take place in the Northeast, and I think we will definitely see more. Among potential targets would be Nstar (NST NYSE). For a long time it was a pretty high-priced stock, in the mid-$40s. I think it now has a pretty decent value. Again I don't think you need to be in a hurry to buy, probably it will come down a little more, but this is definitely one to put on your watch. Another transmission distribution company is Energy East (EAS NYSE), the former New York State Electric and Gas. It has brought a number of other gas and electric utilities in from New England. Just recently, it bought Rochester Gas and Electric. It is rapidly emerging as a regional wire-and-pipe company, and I think could be a nice match for one of the bigger companies in the region. The stock has also come off a little bit here but again they had some nice earnings for the quarter, a very solid and steady company and a very low risk business, strong finances.
"Shifting down south, Energy South (ENSI NASDAQ) is a gas utility based in Alabama and it is also a nice little business in gas storage. It is based in Mobile, Alabama, on the Gulf Coast. In general this is a big gas consumer region. They have made a nice business of gas storage, selling to power plants in the area and other sources. Again it is a very low risk way for them to leverage some growth. It had been very expensive, but now is coming off and we are looking at it as a better value. Atmos Energy (ATO NYSE) is in our growth portfolio. It is one of the more steady ones there. It's the third largest natural gas distributor in the country. They have bought a number of systems around the country. They have done a good job with the regulators in those states getting rates that allowed them to pass weather fluctuation costs onto rate payers. They don't depend on the price of energy. The price of energy could be very high or very low, and they are not going to be that much affected one way or the other. One other one would be Piedmont Natural Gas (PNY NYSE). It owns a lot of gas distribution properties in North Carolina and also Tennessee, and some in South Carolina. They just made a big purchase of a company in North Carolina and they are going to make a lot of money off of adding customers in the system, realizing efficiencies. It is very strong financially and there again, it's coming down in price.
"To summarize, there are going to be more takeovers in the industry. There is no tremendous need to go out and make a lot of purchases right away, but we are seeing values emerge and over a period of time over the next few months, I think we'll be able to point out a large number of good opportunities in this industry. Probably we will see some more correction but most likely as long as the industry is recovering as it is, whatever correction we see is just going to be setting up a buying opportunity."