2 Utilities That Can Weather the Storm

09/02/2011 8:30 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Hurricane season has hit on the East Coast, and it reinforces what investors should look for in utilities: stability, safety, and pragmatism, writes Roger Conrad of Utility Forecaster.

The season’s first major storm for the US—Hurricane Irene—was not as bad as many had expected.

Although it does highlight one fact: Dealing with major storms and their aftermath are part of life in the areas where they’ve historically hit hardest. And the good news is, most pass through with relatively few casualties or property damage.

Despite major innovations in our ability to track weather activity, however, there’s still an element of unpredictability to major storms. And the results can be devastating to those who aren’t fully prepared.

If you’re vacationing in an area while a hurricane is approaching—as many were this week on North Carolina’s Outer Banks—it’s a relatively easy matter to pack up and head inland. It’s a somewhat different kettle of fish for those who own property there. But a good insurance policy—while pricey—will usually compensate.

The same is true for utilities and other owners of essential-service infrastructure. It’s a real testament to the strength of America’s communications network that cellular phone service has become such a hard target for storms—major providers like Verizon Communications (NYSE: VZ) expect few disruptions in wireless networks from Irene.

But storms inevitably bring down trees and the power lines next to them. Particularly major ones can impair safe operation of power plants, pipelines, and even water-treatment facilities. And when a company’s service territory is truly disrupted, the result can be a devastating loss of sales for months, even years.

Six years after Katrina and Rita smashed into the Gulf Coast, that region is still in recovery mode. So is western Missouri, where tornadoes this year devastated the town of Joplin. Rescue and recovery efforts in Japan, meanwhile, may never fully restore coastal regions from the devastation that ripped in from the combination earthquake/tsunami.

Like many Americans, I’ve made a habit of contributing funds to organizations engaged in disaster relief, particularly those focused on these shores. And with this year’s storm season upon us, I strongly encourage others to do the same.

As investors, however, our primary focus is on the companies we own. What’s their exposure to storm season, and could their value and strength as businesses be affected?

Again, every area where a hurricane or storm system hits is going to sustain property damage. The question for an electric, gas, water, or communications company is, does it have the financial resources to make needed recovery and repair efforts without damaging their prospects for growth, dividends, or balance sheets?

Happily, the answer is usually “yes.” Utilities, particularly small ones, generally don’t have the staff on hand to handle disasters on their own. But companies do have the ability to muster crews from across the country to come to their aid in particularly bad cases.

Customers in really hard-hit areas may be out of power for several days, or even weeks in some cases. But sooner or later, repairs are made and service is restored.

There’s a cost to these efforts, and the more devastating the storm, the higher the price will be. Utilities, however, are heavily insured.

And in those very rare circumstances where damages aren’t covered, regulators will assist. That’s a precedent that’s held true even in areas where regulation is considered very difficult, such as the Northeast.

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The most devastating storms ever to hit a US utility were Katrina and Rita, which struck within weeks of each other in 2005. Entergy Corp’s (ETR) New Orleans headquarters was literally under water, as the company lost an entire system and thousands of customers.

Over the past several years, Entergy has had to spend hundreds of millions of dollars to restore service to the Big Easy, as well as to other areas of Louisiana and Texas it serves. But today the region is thriving again, partly thanks to the boom in natural gas liquids (NGLs) on the Gulf Coast.

And the company’s regulated utilities are again going strong. Restoration costs were recovered from a combination of disaster relief, insurance, and regulatory aid. The company was even able to maintain its dividend.

Entergy has reached a deal with the Nuclear Regulatory Commission (NRC) to “improve quality control” at its nuclear fleet, the nation’s second-largest. That’s a plus in the company’s quest to win a license extension for two plants it operates in the Northeast, Pilgrim (Massachusetts) and Indian Point (New York).

Extensions at both plants remain controversial. But the company appears close to getting the NRC’s nod for Pilgrim.

The Indian Point approval has been delayed by New York State’s stalling on a water-quality permit, which the company has challenged unsuccessfully in court. The NRC, however, still seems favorably inclined to approve an extension for the plant, which currently provides a third of New York City’s power and is supported by Mayor Michael Bloomberg.

Entergy shares have dropped to the low $60s—well below my buy target of $80—entirely on concerns about its unregulated nuclear plants. Investors, however, can be confident in the dividend, which is backed fully by the regulated utility operations in the Mid-South.

Overall second quarter earnings were solid, as strength at the utility offset the continued uncertainty at the unregulated nuclear plants. Buy Entergy if you haven’t yet.

Atlantic Power Corp (AT) had perhaps the most positive news. The company is in the process of purchasing privately held Capital Power Partners LP in a deal that would roughly double its size.

The key question mark about the acquisition has been when regulatory approvals will be obtained, at which time Atlantic would have to finance the deal. That’s seemed a somewhat risky proposition in recent weeks, as European sovereign debt woes have festered and Standard & Poor’s cut the US government’s credit rating below AAA for the first time in 70 years.

If Atlantic management has done one thing to perfection over the years, however, it’s been to anticipate where its primary risk lies and to prepare against it. This time around is the exception, as management has now obtained funding that allows it considerable flexibility for permanent financing.

Should credit tighten up, the company will be able to wait it out until conditions improve. And should conditions remain as favorable as they are now, they’ll lock in low cost financing much the sooner. Atlantic Power is still a buy for those who don’t already own it.

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