By Don Diaz, Contributing Editor
2001 will be marked as a year of contrasting boons and busts, with many energy-sector firms logging either solid profits or devastating losses. Overall, the sector lagged behind rebounding technology issues, ending the year (as of Oct. 23, 2001) without a member in the S&P 500’s top twenty best performing stocks.
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Adding to the sector’s woes was the fact that, of all the index’s 87 industry groups, not one energy-related group finished the year in positive territory. In fact, three of the sector’s groups, oil well equipment and services, oil and gas drilling, and the natural gas group were among the index’s worst performing groups on the year. Of course, it was not exactly a bang-up year for the broad-based index as a whole, falling 17.5 percent as of the above-mentioned date.
Top ten best & worst S&P 500 industry groups in 2001: Scattered bright spots
Despite the sector’s overall lackluster showing in 2001, there were numerous individual bright spots among energy-related companies during the year. Many of these firms fall into the Standard & Poor’s Utilities (electric power companies) Index Group, which, like the broader sector, faired poorly in 2001, losing 12.1 percent. However, firms such as Southern Co. (NYSE:SO) and its former power-marketing unit Mirant Corp. (NYSE:MIR) both posted positive returns on the year, the former charting the best performance of all 27 members in the group, its stock price surging 21 percent from Dec. 29, 2000 to Oct. 23, 2001 (see table).
Akron, Ohio-based FirstEnergy Corp. (NYSE:FE) also turned in a stellar performance this year. The energy holding company, which provides electricity to customers in Ohio and Pennsylvania, saw its stock price rise 14.2 percent in 2001. GPU Inc. (NYSE:GPU), another electric utility holding company, rose just over 10 percent this year. GPU’s stock rebounded from a 52-week low of $28 on April 25, to climb to just over $40 per share, a new 52-week high. Holders of GPU stock have realized a 31 percent one-year total return, and an indicated gross yield of 5.4 percent. Long-term growth for GPU is expected to be a paltry 2.8 percent over the next five years, a testament to its huge retrenchment this year.
DTE Energy (NYSE:DTE) is yet another electricity holding company that bucked the overall sector trend, gaining 8.4 percent in stock value in 2001. The firm owns the Detroit Edison Co., which generates, buys, sells, and transmits electric energy in southeastern Michigan. Niagara Mohawk (NYSE:NMK), Con Edison Inc. (NYSE:ED), Mirant Corp. (NYSE:MIR), and TXU Corp. (NYSE:TXU) round out the group’s top performers showing positive gains for the year. PG&E Corp. (NYSE:PCG) and Xcel Energy Inc. (NYSE:XEL) closed the year with the index’s number ninth and tenth best showings, albeit with negative year-to-date returns, of -.50 percent, and -1.63 percent respectively, highlighting the sector’s weakness
Losses & laggards
Exelon Corp. (NYSE:EXC) closed the year with the worst return among all of the 27 companies that make up the S&P 500’s Utilities Index, its stock price plunging nearly 42 percent in 2001. As a result, Goldman, Sachs & Co. slashed its fiscal year 2002 earnings estimate for Exelon Corp., from $5.40 per share to $4.85, but still maintains the company’s stock on its “recommend list.” The firm, despite its recent financial woes, continues to pay regular cash dividends, something all but unheard of in the much ballyhooed, rebounding technology sector. Still, Wall Street is taking a dim view of Exelon Corp.’s ability to grow its dividends, calling for a 2.2 percent decline in dividend growth over the next five years. Constellation Energy Group Inc. (NYSE:CEG) is another laggard within the group.
This holding company has operations throughout North America and various Latin American countries. It generates, purchases and sells electricity, as well as, buys, sells and transports natural gas through its Baltimore Gas and Electric Co. subsidiary. Constellation Energy’s equity price fell by 40 percent in 2001, mainly as a result of plummeting prices for wholesale power, and lower prices in the forward power markets. The company cut its earnings guidance for its fiscal year 2002 in the wake of its financial troubles in 2001. Additionally, the firm was forced to cancel its plans of separating its power-generating business from its utility company, Baltimore Gas & Electric. Constellation’s actions are a function of an overall trend within the sector, in which power generation entities, spun off from utility companies, have suffered as a result of spiraling prices in the U.S. electricity market. In the wake of this move, the company also had to pay Goldman, Sachs & Co. $355 million in order to end the two firms’ failed joint venture. Originally, Goldman had agreed to provide a $250 million investment in Constellation Energy’s power-generating component. Both firms indicated that the termination of their partnership was a mutual decision, with Goldman remaining as the energy company’s advisor. Goldman had already given Constellation $159 million, which the firm used to set up an energy-trading floor. The Wall Street investment bank would have owned as much as 17.5 percent of Constellation’s power-generation unit had the partnership not been cancelled. Goldman’s divestiture appears to be a shift in its business strategy, as the company sold a 37 percent stake in Orion Power Holdings Inc. (NYSE:ORN) in September, netting $600 million from the sale.
Top ten best & worst performing S&P 500 power companies in 2001:Small profits in marketing & trading
As the year 2001 advanced to its close, energy marketing and trading corporations found it increasingly more difficult to derive large profits from these operations. Falling power prices, and falling gas prices combined with much lower volatility in the overall energy markets to result in this outcome.
Reliant Resources Inc. (NYSE:RRI), a spin-off of Houston-based utility company Reliant Energy Inc. (NYSE:REI) has seen its shares drop 49 percent since its IPO in April of this year. Southern Co.’s spin-off Mirant Corp., in September of last year, has also incurred large declines in its stock price, off 41 percent from its high of $47.20 in May. Mirant’s decline is especially troubling for the sector, as the company closed the year among the group’s top performers as described earlier. UtiliCorp United Inc.’s (NYSE:UCU) April IPO of Aquila Inc. (NYSE:ILA), which it owns an 80 percent stake in, has fallen 11 percent since its issue.
[Editor’s note: As of early November, UtiliCorp United planned to reacquire the 20 percent stake of its Aquila subsidary it spun off.]
Bigger’s not better-No escaping the carnage
Even the behemoths of the sector have been unable to escape the energy market’s carnage of 2001. Duke Energy Corp. (NYSE:DUK) ended the year with loss of 9.3 percent in its share price, accounting for its thirteenth place finish in the S&P’s Utilities Index. Duke, despite its huge size, and nearly $30 billion market cap, managed only one positive quarter in 2001, gaining a feeble 0.3 percent in the second three-month period of the year. Duke’s stock has fallen sharply from its year-to-date high of $47.74 set on May 22. Still, the company believes that its earnings will increase in 2002, with its guidance set for a 29.4 percent surge in year-over-year earnings per share. Duke is also expecting increased revenue from its nuclear power plant, Catawba 2, located in Clover, S.C. The facility has a capacity of 1,129 MW, and is currently operating at an output of 62 percent its capacity (as of Oct. 26, 2001). The firm reported that the plant was back online as of October 22, after going offline on September 15.
Enron Corp. (NYSE:ENE) was perhaps the most maligned sector-member in 2001. The company’s stock valued death spiraled, plunging over 81 percent on the year, amid a quagmire of management scandals, lawsuits and trading problems. Enron’s stock is included in an amazing 33 different equity indices, finishing the year at (or near) the bottom of most. The planet’s largest energy trader (although the company has never wholly embraced its trading label) also suffers from a very poor image problem, which was exacerbated by its latest troubles. Wall Street analysts continue to derisively refer to the firm as the “black box”, claiming the company does little to improve its problems with transparency. Unsurprisingly, Enron was unable to muster a positive showing in any of the year’s four quarters, with its best return a 5.1 percent loss in its fiscal first quarter. The energy trading-house saw its share price plummet nearly 50 percent in the fourth quarter alone. Moody’s Investors Services downgraded Enron’s credit rating in the fallout created from its losses in its private partnerships, which is likely to hinder the world’s largest energy trader from borrowing the short-term cash it needs to run its day-to-day operations.
The “black box” was not alone, however, in its poor returns, as other group member such as Dynegy Inc. (NYSE:DYN), El Paso Corp., (NYSE:EPG), Kinder Morgan (NYSE:KMI), Sempra Energy (NYSE:SRE), Nicor Inc., (NYSE:GAS), Peoples Energy (NYSE:PGL), Keyspan Corp., (NYSE:KSE), Williams Companies Inc., (NYSE:WMB), and Nisource Inc. (NYSE:NI) all closing 2001 with negative year-to-date returns.
Sliding price woes
The overall sector’s poor performance was due mainly to sliding power, gas and oil prices, both in the spot and future, or forward markets. Adding to this problem was the ever-slowing U.S. economy and the horrible terrorists attacks on the nation on September 11. All of these factors combined, along with ongoing weakness in the equity markets, to produce the energy-sector outcome of 2001. U.S. corporate earnings show little sign of rebounding, falling 21 percent in the third quarter, their third consecutive quarterly decline. This trend appears likely to continue, possibly for the next two quarters, which would make the current decline in corporate profits the longest in over 30 years. The last time the nation endured five straight quarters of falling corporate earnings was in 1969-1970.
Looking ahead to 2002, there is no clear indication that signals an energy-market retrenchment. Energy marketing and trading firms appear headed, at least for the near-term, for more down trending (especially in light of the constant evolution taking place in these markets, which makes Wall Street’s task of placing values on these firm’s operations all the more difficult). Earnings derived from wholesale energy trading and marketing businesses have become increasingly more dependent on the hedging of production and market positions. This combined with the growing difficulty in predicting earnings based solely on energy prices, and their respective forward prices curves, outline the complexities inherit in the valuation of the sector. Success within these firms’ core lines of business will continue to hinge upon the success in hedging future energy transactions, becoming less reliant on physical trades, while skillfully exploiting the ever-expanding, lucrative, financially based, structured transactions market.
Don Diaz is a senior market analyst and contributing editor with Wallstreetcity.com. His financial career spans 14 years, encompassing the debt, equity and currency markets.