Talking Utilities With A Guy Who's Plugged In
William H. Reaves has witnessed all kinds of markets in the 47 years he has been following utility stocks. As head of W.H. Reaves in Jersey City, he manages more than $1.1 billion in assets for a number of institutional clients. Over the past 30 years, Reaves has bested the total return of the Standard & Poor's 500-stock index by about 4% on average. Last July 1, Reaves began managing Strong American Utilities Fund. Soon after, higher interest rates and other unwelcome sparks began short-circuiting electric utility stocks. The affable South Carolina native recently discussed the state of electric utilities with business week's Edward C. Baig.
QThis is a particularly tough time for electric utilities. What will it take to turn this group around?
AThe electric-utility group is so much out of favor now that it's hard to remember how popular it was [last summer]. Actually, when a group is very much out of favor, the pickings start to get pretty good. If interest rates continue on an upward trend, it's going to be a tough climate. If rates decline, people would be rather surprised at how nicely utilities can snap back. At present, we have about 25% in electrics, 46% in telephones, 5% in gas stocks, 18% in energy, and the rest in cash.
QOne potential threat is that some states are considering letting big electrical customers buy power from any producer.
AThere are going to be some fundamental changes in the industry structure. Some of these changes can add financial risk to certain companies. It is likely to develop over years, and strong companies can take advantage of opportunities.
QWhich companies do you like?
AMost electric utilities will remain financially strong. These companies have good cash flow and [no major] construction needs and really good management. You have to slim down to a few really strong horses that you have great confidence in. You also have to recognize that when a market decline happens, the good and bad fall together. So you can make a shift from this one to that one and add to your potential.
We're investing long-term with Duke Power, Southern, and TECO Energy. We're confident they can continue to compound values at an advantageous rate. TECO and Duke [were such] superior companies that we basically couldn't afford to own them. So when the decline came, and the good and bad fell, we said: "Thank you very much."
You need companies that are reasonably regulated and have rate structures and economics in good shape. Unless something comes out of left field--inflation, major cost upheavals--you can get by fine and benefit by cutting costs. Southern and Duke are in that category. TECO is building a state-of-the-art, low-cost, efficient power plant and getting what we call good work-in-progress support, meaning they can collect a return in their rates during the construction period. SCANA is another good company building a plant and getting work-in-progress support.
For many other companies, just because they're out of favor doesn't mean you have to hide under your desk. Public Service Enterprise Group's rate structure is sound. Boston Edison is another one in a good position. If you have a company like Public Service that yields 8.5%, you can take a big slam in the marketplace and your dividend bails you out.
QWere you surprised that Florida Power & Light cut its dividend even when the company was relatively healthy?
AI think everybody was surprised. What FPL did was dishonorable. Here is a company that says: "We are financially healthy. So we're going to sacrifice our own shareholders and use a lot of that to buy back shares and, having done that, show you a 5% earnings gain and encourage people to hope for a dividend increase of about 5% next February."
That's smoke and mirrors. If this trend is picked up by any significant [number of others], then I guess this industry will sell below book value. I certainly hope not. I do not expect it. [Reaves did anticipate the dividend cut announced on June 16 by SCEcorp, the holding company for Southern California Edison.]
QSo you think electric utilities are safe?
AYou have to be careful and alert, and we plan to be. People who manage utility portfolios have to be alert to the regulatory situation affecting each company. And if [utility managers] end up with an impossibly destructive regulatory situation, I have to ask what they are doing at the legislative level to help change it in a constructive way.
Most of the companies are strong financially and are going to remain so for an indefinite period. They will be able to carry us across the valley until we see what the rules are going to be.
LIGHTING UP YOUR PORTFOLIO? Stock price Yield 6/20/94 BOSTON EDISON $26 3/4 6.6% DUKE POWER 36 5.2 PUBLIC SERVICE ENTERPRISE GROUP 25 1/2 8.5 SCANA 44 1/2 6.3 SOUTHERN COS. 19 1/8 6.2 TECO ENERGY 19 1/2 5.2 DATA: W.H. REAVES & CO.