Top 20, and Why Financial Strength Matters

Take a look at this issue’s Mega Metrics feature. It has our 2016 Top Twenty Financial Performers.

Top Twenty? I know what you’re thinking. Isn’t this annual ranking of ours a top forty? 

It’s not that the list has half the companies and therefore is half as valuable. Yes, the list is half the size. But it’s twice as valuable. Or thereabouts.

The Top Twenty ranking is now limited to investor-owned electric utilities and combination electric and gas utilities. It’s also limited to such companies, electrics and combos, with revenues last year of at least a billion.

We did this so as to not mix up large electrics and combos with companies that are miles apart in strategy, situation and size. There are many great investor-owned electrics that are relatively small. And there are many great gas utilities, large and small. And great non-utilities that own and operate electric and gas assets.

But as investments, they’re not all that comparable, if we put them in a single bucket with large electrics and combos. The bucket would be too varied for the purpose.

In the world of finance, investors have numerous choices as to where to place their bets. It’s unclear that investors consider as comparable, a large electric with a large or small gas, any more than with a large highly-regulated non-energy company.

There’s a second reason to shrink our annual ranking from forty to twenty. As chronicled in the series of articles by Tom Flaherty, the total number of electrics and combos and gas companies is shrinking. (See “Lessons for Tomorrow’s Deals,” Sept. 2016, and “Expanding Deals, Shrinking Companies,” June 2016.)

It made sense to highlight forty firms when there were well over a hundred in aggregate. But when there are half that number in aggregate?

The Top Twenty ranking is a good read. Who’s on top? Who’s not?

But why does it matter? It does matter. Because the financial strength of our utilities matter, and not just for shareholders.

We must put forth, at first, an important caveat. If you believe the nation’s electric grid (including its generating, transmission and distribution infrastructure) doesn’t need much tending to, doesn’t need much capital investment, then the financial strength of our utilities doesn’t matter much to you.

But consider the converse. If you believe the grid does need much tending to, does need much investment, then the financial strength of our utilities does matter a whole lot to you.

Notwithstanding all the rhetoric about the utility of the future, I’m supposing that most of you agree that grid upkeep and modernization is vital to the welfare of our communities and families. And thus utility financial strength is as vital.

Now agreement does break down once we dig deeper. The debate reminds me of my work in national defense strategy when I was much younger. The basic question is this. How much defense capability is enough (in quantity and quality of military equipment and the armed forces)? How much is too much?

The same basic question faces us when we think about utility financial strength, and its regulatory underpinnings such as return for shareholders. How much utility capability is enough (in quantity and quality of grid equipment and the workforce)? How much is too much?

Yet, this basic question is tougher to address for us, than for the world of defense strategy. In defense, the federal government approves a certain budget for our force structure. That’s more or less it. The Pentagon then has a fixed amount of financial resources to get the biggest bang for the buck, in terms of maximizing national security.

In utilities, regulators approve a certain budget of sorts, the revenue requirement, for a utility. However, that’s hardly it. The utility then has a range of financial resources to get the biggest bang for the buck, in terms of maximizing service reliability.

Why a range of financial resources rather than a fixed amount? Because the utility leverages its financial strength, provided in regulatory orders, to use the substantial funds of equity and debt investors, to multiply the resources for reliability.

The more the return for shareholders, the more funds investors are willing to let a utility use. The less the return for shareholders, the less funds investors are willing to let a utility use, versus let some other companies use.

In rate cases, we wish we had a magic formula. If the allowed return on equity is set at eleven percent, for example, a utility will have enough financial strength to do everything customers would want, to maximize their service reliability. If the allowed return is set at ten percent, the utility won’t. Ten and a half percent? How much reliability does that buy customers?

Regrettably, there is no such magic formula. My apologies to rate-of-return expert witnesses, an exclusive club of which I was once a member.

Indeed, it’s a perception game. Thomas Edison Power and Light is perceived by the financial community to be financially strong. Nikola Tesla Gas and Electric is perceived by them to be weak. And George Westinghouse Energy is perceived by them to be in the middle.

So investors are eager to put their money down for Thomas Edison P&L, reluctant to do so for Nikola Tesla G&E, and wary to do so for George Westinghouse Energy. The communities and families served by Thomas Edison P&L will get the best equipment and people to keep the lights on through storms.

Those served by Nikola Tesla G&E will be short-changed.

If it’s a perception game, that means utilities, regulators and intervenors are all on the same team. However much they squabble in the hearing room, they must jointly persuade the financial community that a utility is strong enough to take good care of investor funds, all the funds that can be effectively deployed to maximize service reliability.

That is, again, if you feel maintenance and modernization of our electricity infrastructure is a priority for the customers we represent and serve. I know there are folks that have other priorities, such as making the grid plug-and-play for new entrants. They might believe the return for utility shareholders may as well be zero. Though I doubt these folks would reach their goals in a darkened future of weakened utilities.