The power sector’s 1Q review: Life after Enron

By Don Diaz , Contributing Editor

Despite signs that the U.S. economy continues to recover from a recession that began in March of last year, corporate earnings and stock prices remain lackluster. What holds true for the market in general is representative of returns among power sector firms in the first quarter of 2002. Concerns over accounting practices and firm accountability (offspring of Enron fallout), as well as resulting investor angst, have all acted to curb the sector’s first quarter showing. Nevertheless, the quarter did demonstrate a rebound, albeit meager, from its returns in 2001.

The S&P 500’s Utilities Index Group (made up of 27 electric utility companies) posted a loss of slightly over 12 percent for all of 2001. In the first three months of 2002, the index climbed 3.6 percent, a possible indication that this year’s sector trend will remain positive. Firms such as PG&E Corp. (NYSE:PCG), and Constellation Energy (NYSE:CEG) posted significant trend reversals within the quarter, greatly contributing to the index’s gain.

In 2001, Constellation Energy closed the year among the group’s worst performing members. Its stock price plunged nearly 40 percent. Not so in 2002, as the company’s stock rose 18 percent to close the first quarter as the index’s second-best performer.

PG&E Corp. ended the quarter with a gain of just over 20.5 percent as the top index returnee (compared to 0.50 percent loss for all of 2001).

The sector saw other similar index movers bucking their 2001 trends. Allegheny Energy (NYSE:AYE) finished the year off a dismal 26.56 percent, but rebounded in the first quarter, rising nearly 17 percent. Exelon Corp. (NYSE:EXC) charted the most dramatic turnaround of all index members, reversing its dead last, 42 percent loss in 2001, to close the quarter up 10 percent, ninth out of the top ten index-member firms for the quarter. TXU Corp. (NYSE:TXU) closed the first quarter with a gain of over 17 percent, up from a paltry 0.83 percent advance last year.

These returns more closely mirror the utility index’s long-term performance, which has risen over 23 percent since 1997. However, the first quarter did present new lagging index members, which had posted solid returns in the previous year.

FirstEnergy Corp. (NYSE:FE) saw its stock price drop 5.7 percent during the quarter, disappointing investors and analysts after its 14.3 percent gain in 2001. A March shutdown of its Oak Harbor, Ohio nuclear power plant lowered earnings estimates for the company in 2002, negatively affecting its share value for the quarter.

Mirant Corp. (NYSE:MIR) stock value fell 9.8 percent in the first quarter, off from its 1.9 percent advance in 2001.

Industry behemoth Duke Energy (NYSE:DUK), although financially solid, continued to post dreary returns, falling 2.96 percent for the quarter following a 9.3 percent decline for all of last year. Duke’s problems highlight ongoing sector challenges, which hurt industry profit projections. Falling power prices continue to apply downward pressure on power plant asset valuations, which in turn drive down share prices.

Acceleration of project cancellations combined with diminishing industry backlogs has forced many sector members to slash their earnings estimates. Credit ratings of outstanding debt securities have eroded, a direct result of Enron’s implosion. Re-regulation of the sector by the federal government is also being revisited, also a result of Enron-ism. This trend will likely continue until public scrutiny of the sector’s accounting and business practices is resolved.

The sector will continue to face Enron-exacerbated obstacles to profitability. Federal monitoring of tax shelters (both offshore and in the U.S.), as well as ever more unforgiving capital market structures, will allow for only the most liquid of sector players to excel over the long-term.

Notwithstanding these circumstances, sector members persist with innovation and implementation of power generation and, accordingly, to show profits, as evidenced by the first quarter of 2002’s index results. Outlook for the balance of the year remains guarded, but nowhere near the bleakness called for as recently as year-end.

Sector firms with clean balance sheets and functional business plans will emerge from the industry’s current morass as leaders with appreciating equity values. Firms lacking these assets will be weeded out over time, mired in the offal of a post-Enron marketplace.

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.

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