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Hunting for Utility Stocks? It's New Breed Versus the Old


When Duke Energy Corp. purchased a Texas gas pipeline company in 1997, the biggest U.S. utility owner didn't know just how large an earnings boost would result.

The $9.8-billion acquisition of PanEnergy Corp. gave Charlotte, N.C.-based Duke plentiful supplies of natural gas. Some of that gas has been used this summer to run power plants Duke has purchased in California in recent years. And those plants, in turn, have cashed in on average California electricity prices as high as $665 a megawatt hour this summer--26 times year-earlier levels.

PanEnergy provided "everything we had bargained for and then some," said Duke Chief Financial Officer Richard Osborne. "It made us an integrated energy company, and that's what it's going to take to succeed in this world."

A doubling in natural gas prices in the past year and increased demand for electric power nationwide have helped create a tremendous rally in many utility stocks this year. Indeed, this once-stodgy industry has put the technology sector to shame.

In the third quarter alone, the Dow utility-stock index surged 30%. It's now up 42% year to date. By contrast, the tech-heavy Nasdaq composite stock index is down 12.3% for the year.

Utility stocks have been driven in recent weeks by expectations for hefty third-quarter earnings gains at such power generators as Duke (ticker symbol: DUK), Calpine Corp. (CPN), Dynegy Inc. (DYN) and others.

Duke's per-share profit in the third quarter is expected to rise 16% to $1.34 a share, based on the latest First Call/Thomson Financial survey of analysts' estimates. The company's revenue is projected to climb as much as 84% to $40 billion this year, Osborne said.

Reliant Energy Inc. (REI) and NRG Energy Inc. (NRG), two companies that own power plants in the Northeast and California, already have told investors that earnings will be higher than forecast.

"Utilities, by and large, are encouraging analysts to increase their growth forecasts," said Gregory Phelps, a fund manager at John Hancock Advisers Inc. in Boston.

But the new wealth isn't spread equally: Utilities that are viewed as struggling in the increasingly deregulated environment are, not surprisingly, finding their stocks badly lagging those of their peers.

California's three main utilities--PG&E Corp. (PCG), Southern California Edison parent Edison International (EIX) and Sempra Energy (SRE)--are near the bottom of the list in terms of stock performance this year.

Those stocks also are priced at very low levels relative to earnings per share. Those low price-to-earnings ratios reflect, in part, investors' questions about the companies' abilities to recoup losses they have incurred buying expensive power while being forced to sell at capped prices.

PG&E said it rolled up a debt of $2.2 billion from June through August because the company purchased electricity at prices that were higher than it could charge its customers.

By contrast, Wall Street apparently has tremendous faith in the earnings potential of San Jose-based Calpine.

The company bought gas-producing properties in Canada and the U.S. for $206 million in July to fuel the new power plants it's building, which include 1,045 megawatts of capacity in California coming into service next year. That's enough power to light more than 1 million homes.

Calpine, which has power plants in 27 U.S. states and in Alberta, Canada, has posted triple-digit earnings growth for the last six quarters, and may earn 76 cents a share in the third quarter--more than double last year's profit from operations, analysts said.

Earnings in 2001 are expected to rise 25% from this year's level.

Investors have driven Calpine's stock up 218% so far this year. The stock now has a P/E of 69 based on expected 2000 results. That puts it into the rarefied P/E air of many tech stocks.

Analysts say the new breed of utilities deserve higher stock valuations than their peers, although the higher P/Es clearly raise the risk in the stocks. Also, dividend yields on the new-breed stocks are low or non-existent compared with other utilities.

Gains for power generators such as Calpine have come in part at the expense of utilities that sold power plants to focus on delivering electricity. PG&E and Edison International are in the latter group.

Edison also has faced other problems this year. Its stock plunged in March after the company warned that earnings would be lower this year because of a drop in power prices in Britain, where the company owns two power plants.

Another Edison--Consolidated Edison--raised prices for its more than 3 million customers in the New York City area this summer by as much as 40% because of higher prices charged by other power plant owners in the region.

Con Ed has been criticized by New York officials for not having enough electricity available for customers. Part of the problem has been that the company hasn't been able to run its Indian Point 2 nuclear reactor.

Con Ed is expected to earn $1.40 a share this quarter, less than the $1.50 in the year-ago period, according to First Call. And in contrast to other utilities, analysts expect little growth for Con Ed's earnings in 2001 compared with 2000.


Tracking Major Electric Utility Stocks

Here's a look at some of the major players in the electric-generation business nationwide, and how their stocks have fared in this year's rally. Also shown are analysts' consensus earnings estimates for each company for 2000 and 2001, each stock's price-to-earnings ratio based on estimated 2000 earnings, and each stock's dividend yield (annual dividend divided by current stock price).


Source: Bloomberg News, Zacks Investment Research (earnings estimates), Times research

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