The F40 methodology, developed by Public Utilities Fortnightly and the C Three Group of Atlanta, uses a modified Du Pont model to rank companies' shareholder value by comparing publicly reported financial data - such as profit margin, return on equity (ROE), return on assets (ROA) and sustainable growth.
Companies topping the F40 ranking this year are Energen, PPL and National Fuel Gas. Achieving the 40-company ranking for the first time are Dominion Resources (17), Alliant (26), El Paso Electric (31), Delta Natural Gas (35) and CenterPoint Energy (38). One of the biggest movers in the F40 is New Jersey Natural Gas, which ranks 10th this year after falling off the list last year, and ranking 38th in the 2006 F40. Several major utility holding companies failed to make the cut this year. Examples include Constellation Energy, FPL Group, Duke Energy and Progress Energy.
Data in the report show that average stock prices for the 2008 F40 companies grew by about one-third during the period from 2005 through 2007, while average dividend yield fell by 50 basis points during the same period - from 3.7 percent to 3.2 percent. These trends tracked a major surge in capital spending; the F40's cap-ex grew by 47 percent from 2005 to 2007, with the F40 companies dedicating $96.2 billion to capital expenditures over the three-year period. The entire 87-company sample spent nearly $200 billion.
"The utility industry's Big Build officially has begun," said Michael Burr, editor-in-chief of Public Utilities Fortnightly and author of the report. "The F40 companies spent more on cap-ex in 2007 than they earned from continuing operations, signaling the beginning of a long period of negative free cash flow. We'll be running in the red for several years as the build-out proceeds."
Utility executives interviewed for the report confirmed aggressive plans for new construction. "Over the next four years, projects we have planned and underway will more than double our domestic transmission rate base," said Paul Farr, CFO of PPL Corp.
At the same time, however, the F40 companies' returns are rising - largely in proportion to their participation in deregulated markets. "For the first time since the Enron collapse and the industry's refocus on core business, the pendulum has shifted toward commodity exposure driving returns," said Jack Azagury, a partner with Accenture. "If you have E&P exposure, or a big merchant-power portfolio, margins will be very strong for the next few years."
Allowed returns among rate-regulated utilities face pressure, however, as rising costs for commodities, labor and cap-ex make their way into rate cases, and state utility commissions try to prevent rate shock among retail customers. "Managing regulatory relationships is perhaps the biggest challenge utilities will face," said Jean Reaves Rollins, managing partner with the C Three Group. "Getting those relationships right will determine utilities' financial health in the future."
In the same issue as the F40 report, Public Utilities Fortnightly published data showing that over the past dozen years, the average authorized ROE for U.S. electric and gas utilities has declined by about 180 basis points - from just over 12 percent in 1996 to less than 10.5 percent today. "To the degree the utility industry is becoming more uncertain and complex, regulated ROE is going in the wrong direction," Burr said.
