INSIGHTS

On November 27, 2012

The Effects of Hurricane Sandy on Utilities

The damage caused by Hurricane Sandy was widespread causing more than two million customers to lose power. Utilities especially hard hit include Consolidated Edison (ED), First Energy (FE), Public Service Group (PEG) and Excelon (EXC). The cost to repair damages and return electric service to homes has not been determined, but will undoubtedly be in the hundreds of millions. Importantly, most state regulators generally allow utilities to defer abnormal costs associated with natural disasters and file for recovery of the costs. Thus, the financial impact of Hurricane Sandy upon utilities is probably not as great as one might initially think. That said, utilities may not get recovery of lost sales or all operating costs.

Performance: Utility stocks, as measured by the Philadelphia Utility Index, rose 1.2% in the month of October versus a 2.5% loss for the Dow Jones Industrial Average. Strong utility results came despite a rise in long-term interest rates. We believe the relative outperformance can be explained by the rise in natural gas and power prices and the positive impact upon unregulated merchant energy results.

September Quarter Results: Earnings for the September quarter were generally being reported near analyst expectations. Electric distribution results in the Northeastern quadrant of the United States were strong due to favorable weather conditions. Merchant Power and Exploration and Production results remain depressed due to low energy prices, but are showing signs of improving. Midstream gas and oil liquid results are also depressed as producers have shifted away from dry gas production towards wetter production. Many companies continue to highlight future infrastructure expenditures with several new projects being announced. We continue to believe that accelerated infrastructure spending will lead to above-average earnings growth over the next five to ten years.

Valuation: Utility stocks valuation metrics remain near the upper end of historical trading ranges. The median P/E is approximately 15 times forward earnings and enterprise value to ebitda is approximately 7.5 times. We believe the typical utility stock offers investors a total return of 7-9% based on the median yield of 3.9% and estimated dividend growth of 3-5%. Such a return represents a significant premium over the 2.9% yield provided by 30-year government bonds. Enough premium, in our opinion, to adequately compensate investors for the added risks involved in investing in utility stocks.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com


The information contained herein is obtained from Confluence Investment Management LLC and believed to be reliable. The information is not warranted as to completeness and accuracy and is subject to change without notice. The foregoing has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security.


Advisors Asset Management, Inc. (AAM) and Confluence Investment Management LLC are not affiliated and the views expressed in this commentary are not necessarily that of AAM.

Confluence Investment Management LLC is the Portfolio Consultant to the Confluence Utilities Portfolio. The Portfolio Consultant is not an affiliate of Advisors Asset Management, Inc. (AAM), the sponsor of this trust.