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3 power plays ready to surge
The U.S. power grid is set to get a major upgrade worth billions. Here are 3 companies that are well-positioned to profit.
By Jim Jubak
After doing nothing for more than two decades, utility companies are poised to spend $50 billion to build and upgrade the system of wires and towers used to distribute electricity throughout the United States. And based on recent spending trends, that $50 billion is probably on the low side.
The spending will transform the electrical utility industry. Who knows, some of it may even lower what you pay to heat your home, drive your car and run your refrigerator and air conditioner -- eventually. But way, way before all this spending puts a penny into any consumer's pocket, it will show up in the stock prices of companies in the utility, energy, construction, engineering and manufacturing sectors.
Warren Buffett knows this. That's why he recently bought electric utility PacifiCorp from Scottish Power (SPI, news, msgs) for $5.1 billion. Electric utilities Duke Energy (DUK, news, msgs), American Electric Power (AEP, news, msgs), and Exelon (EXC, news, msgs) know it. That's why they've all bought other utilities in recent quarters. In my June 3 column, "Why Buffett is buying utilities," I gave you my list of electric utility stocks that you could buy -- both those of companies doing the acquiring and those likely to be acquired -- to get in on this trend.
In today's column, I'm going to look at three other stock winners that will gain from the billions in capital spending that will transform the U.S. utility grid in the next decade.
A faulty, patchwork system
The spending flood that I'm talking about is a reaction to a more than two decades-long spending drought. From 1975 to 1999, according to the U.S. Department of Energy, spending on the electricity-transmission system fell by an average of $83 million a year. That trend turned around in 1999, and in the next four years investment rose by 34% over the previous four-year period. Average annual investment in those four years came to $3.6 billion.
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But that uptick in annual investment is just a down payment on the electric grid's needs. Estimates of the cost of expanding and upgrading the grid start at $50 billion and rapidly head north.
Why so much? The grid of high-voltage lines that transmit power for long distances in this country is a patchwork of local systems. It suffers from a mismatch between where the customers for electricity live and work and where the electricity is generated. For example, California, which is starved for power, sits next to power plants in Arizona, hungry for customers. Currently, the grid lacks enough capacity to carry the surplus power from Arizona power plants to California homes. And the grid is full of bottlenecks where one or two regional connections between local systems restrict the amount of power that can be shifted from one area to another to meet a surge in demand. Or provide backup in an emergency.
The Department of Energy estimates that brownouts and blackouts cost the U.S. economy about $80 billion a year.
Plenty of projects in the works
The current fragmented grid is even more of a mismatch with plans for long-distance transmission of bulk electricity from huge centralized power plants. Hey, I've got my doubts that turning the Dakotas into a reservation for coal-fired power plants that ship their electricity to California and Nevada is a good idea, but that's definitely the policy trend du jour. You can see it at the state level in legislation passed to set up the South Dakota Energy Infrastructure Agency that would promote the construction of transmission lines to carry power to other states from coal-fired and wind-powered generating facilities in South Dakota. The same law includes tax breaks for new power plants.
And you can see it in at the national level in the energy bill that is slowly working its way through Congress. The Senate version of the bill, for example, contains $2.25 billion in tax credits for coal production and $278 million in tax credits over 10 years for building advanced nuclear power plants, which, given current well-founded fears of terrorist acts directed at nuclear plants, aren't likely to be sited near the large urban populations that use the power. Oh, and the bill also provides loan guarantees for the construction of nuclear and coal power plants. (You can see why the South Dakota legislature thought there might be a future in building coal-fired power plants and shipping the electricity out of state.)
Prudential Equity Group has put together a list of some of the electric-grid projects now proposed.- $700 million project to connect southern California to power plants in Arizona with excess, unsold capacity. Will serve 900,000 California homes by 2009.
- $300 million project to expand the high-voltage line that connects northern and southern California.
- $3.3 billion project to build the Frontier Line to connect California, Nevada, Utah and Wyoming. Memorandum of understanding signed April 4, 2005.
- $420 million project to connect southern Wisconsin to northern Minnesota to serve 200,000 homes. Potential links could run to Iowa and Illinois.
- $1 billion project to raise transmission capacity in Minnesota.
- $3 billion project to connect Long Island to New Jersey with an underwater link. Eventually the project would stretch to eastern Canada.
- A North Dakota plan to sell $800 million in bonds to finance new transmission lines. New transmission projects would get a five-year property tax exemption.
- $750 million Montana plan -- at the talking stage -- to export coal-generated power over a high-voltage transmission line to Seattle.
- $200 million plan to build two connections between southern Texas and Mexico to supply fast-growing area around Laredo.
- A plan by the province of Alberta to build a transmission line to ship power to Montana. Another project under discussion would ship electricity generated at the province's oil sand deposits to the United States. Alberta has a reported electricity surplus of 30%.
3 potential power plays
What companies -- and stocks -- will benefit? I have three ideas for you. I call them ideas because I don't expect that these stocks will reflect additional revenue from the transmission build-out until the second half of 2005, or, more likely, 2006. (Effects tend to hit about a year after any energy bill is actually passed.) So you might want to research 'em now and buy 'em later.
Quanta Services (PWR, news, msgs) provides specialized design, installation and maintenance services to the telecommunications and utility industries. In recent years, that's meant installing fiber and cable to the home for telephone and cable-TV operators. That business took a hit in the first quarter of 2005, with revenue falling 14% from the first quarter of 2004. (Order backlog, on the other hand, did climb 42%.) And in the future it will mean the kind of transmission work I've described in this column for electric utilities. That segment of the company's business has already started to show a pickup, with revenue climbing 12% in the first quarter. I think growth at something like the first quarter's rate is built into the stock price, however. So if you buy this one now, you're buying in anticipation of improved growth in 2006 as a result of a pickup in utility spending on transmission projects. The Wall Street consensus now calls for 15 cents a share in earnings for 2005 and a jump to 33 cents in 2006. I think that latter number could be low and I'd look for more like 40 cents if the energy bill accelerates transmission-system investment. Quanta Services will report second-quarter earnings on Aug. 1.
InfraSource Services (IFS, news, msgs) is, like Quanta Services, a specialized contractor that provides design, engineering, construction, testing and maintenance services for utility and telecommunications companies. In the first quarter, revenue in the company's biggest unit, electrical distribution, climbed by 12%. But margins fell as more of that work came from lower-margin maintenance work and less from big constructions projects. That trend is evident in the company's backlog numbers, too. They show an increase to $925 million from $790 million in the first quarter of 2004, but most of the increase seems to be from lower-margin maintenance work. A pickup in transmission construction would increase not only revenue but margins, giving a huge boost to earnings. Wall Street analysts now project 39 cents a share in earnings for the second quarter (the company reports on Aug. 8) and 72 cents a share for 2006. On June 16, the company announced that it would recognize a $6 million to $8 million loss on an underground gas-utility construction project. Investors doing their due diligence on InfraSource Services should also note that the company was a May 2004 IPO and, as is frequently the case with relatively recent public companies, pre-public investors still own a large number of shares that they can sell into the market at any time.
Thomas & Betts (TNB, news, msgs) reported revenue of $317 million from its electrical segment, its biggest business, and certainly sales of utilities of electrical connectors and components figure into that revenue total. But its the company's smaller steel-structures segment, which builds and sells steel utility polls, that gives Thomas & Betts the most leverage to a pickup in transmission construction. The company recently purchased Southern Monopole, which added $5 million in sales to steel-structures-sales revenue of $45 million for the first quarter of 2005. Operating margins for the steel-structures business picked up modestly in the first quarter; I'd expect higher revenues to increase margins for the rest of 2005 and into 2006. Wall Street analysts are projecting earnings of $1.79 a share in 2005, 25% growth, and then $2.07 a share in 2006. That would mark a slowdown to 15% growth, still quite respectable for a stock selling at 16 times projected 2005 earnings per share. The shares would be even more intriguing, of course, if new transmission construction pushed earnings above Wall Street estimates in 2006. Thomas & Betts reports second-quarter earnings on July 18.
There's a clue in all these plans for more transmission lines -- and more clues in the Senate's version of the energy bill -- to how high oil prices might go before market forces of supply and demand kick in to give consumers a break. In my next column, I'll try to read those clues and answer "How high will oil go?"
New developments on past columns
10 hated stocks you'll love in 2005
I'd call the quarterly numbers announced on June 23 by Micron Technology (MU, news, msgs) terrible -- except that they were worse than that. Officially, Wall Street had been calling for earnings of 5 cents a share and instead the company announced a loss of 20 cents a share. The bad news didn't stop there: Gross margins fell to 8.2% from 27% in the prior quarter, and the company's average selling price (ASP) in its core memory-chip business dropped 33% from the prior quarter. I say "officially" because I suspect that Wall Street had already heavily discounted its own projections. That's why the shares dropped just 5% in the two sessions after the announcement of these horrible numbers. The truth is that everyone who owns Micron Technology here -- yours truly included -- is just hanging on waiting for the turn in the company's business. Each quarter recently, the company has teased and then disappointed, but that hasn't destroyed belief in an eventual turnaround. And with each disappointment, the stock has become just a little cheaper, making the reward for waiting more attractive. Micron Technology now sells at a price-to-book value ratio of 1.1 -- that's at the low end of the 10-year range for the stock. All things considered, including the company's record of disappointment, I think it's worth waiting a little longer for the turnaround. DRAM memory-chip pricing has stabilized in the last month, it appears, in both the contract and spot markets, and contract prices have actually climbed in recent weeks. Micron Technology typically sees the strongest memory-chip demand in the next two quarters. So with hope that this quarter was as bad as it gets, I'm keeping the stock in Jubak's Picks and keeping my target price at $15 a share but stretching out my target date to December from June. (Full disclosure: I own shares of Micron Technology.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Micron Technology. He does not own short positions in any stock mentioned in this column.
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