Utilities: Three on the Gulf

09/09/2005 12:00 am EST

Focus:

Roger Conrad

Founder and Chief Editor, Capitalist Times

"The aftershocks of Katrina will be felt for months, if not years," notes Roger Conrad. Indeed, many investors will be concerned about the impact of Katrina on their utility stock holdings in this region. Here, the utility expert assesses the outlook.

"We have taken a hard look at three companies in the aftermath of Katrina: CLECO (CNL NYSE), Entergy (ETR NYSE), and Southern Company (SO NYSE). These three are the principal utilities whose service territories were in the path of the storm. That’s guaranteed to bring them bad publicity, at least in the eyes of Wall Street, which will induce some investors to sell.

"That will almost surely be a serious mistake. All three face heavy costs and reconstruction that will likely take months to complete. But regulated utilities are almost always made whole in the wake of storms, from insurance and (especially) by regulators. Florida’s battered utilities, for example, have been allowed to recover virtually all system damages, which neared a trillion dollars. Earnings were temporarily impacted by costs, but dividends held and share prices recovered quickly.

"All three of these companies are financially strong and getting stronger. That gives them a solid cushion for whatever damage they do suffer. Entergy and Southern are two of the strongest utilities in the country. CLECO, meanwhile, has at last resolved its merchant energy liabilities by completing the sale of one power plant and resolving a dispute with Calpine over a power sales contract.

"New Orleans-based Entergy was the worst affected by the storm. Given the state of its home city now, the company will almost surely suffer a severe drop in sales in the near term, with a particular impact in the third quarter. As long as certain areas remain underwater, it will be impossible to restore electricity to them. However, the company should be able to make major inroads in the coming weeks on the 1.08 million customers estimated to have been without power at the peak of outages.

"The key will be how the utility works with local authorities to restore power to areas as they again become habitable. If they can keep the inevitable high profile complaints to a minimum, regulators will be ready to work with them on recovering costs. That’s what I expect to see happen in the coming weeks. My buy target on Entergy shares is 72, below where they’ve traded recently. Given the magnitude of its task in restoring its system to full power, it’s a good bet they’ll break that point in the coming days. When it does, it will be a strong long-term value.

"Most of Southern Company’s vast southeastern service territory was untouched by the storm. That’s very good news for its prospects for recovery from this storm. So is the precedent of storms hitting its Gulf Coast territory last year, which inflicted only a minor dent on results even before cost recovery. Southern Company is pricey, but we may see a Katrina-related dip below my buy target of 33.

"Since the utility bear market of 2001-02, CLECO has faced the threat of dividend cuts and even potential bankruptcy, arising from its remaining liabilities in merchant energy. The bad news is it faces hefty system cleanup expenses. The good news is those costs will now be borne by its regulated utility operation, unhindered by potentially huge unregulated liability. My chief problem with the stock in recent months has been price, as relieved investors have bid the shares up well past near-term prospects. Fallout from the storm may give us the entry point we need. I rate CLECO a buy on any dip to 18 or lower."

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