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posted on 11 May 2016

Electric Cars To The Rescue?

by Richard Stavros

Investing Daily Article of the Week

As utility investors, right now times are good. The Dow Jones Utilities Average is up nearly 15% year to date, compared to just 1.7% for the S&P 500.

Of course, utilities are benefitting from the fact that times are not so good for everyone else. As a safe-haven investment, utility stocks tend to gain when uncertainty causes most other stocks to lose ground.

But this recent action masks a longer-term concern for the sector: Growth in electricity demand has been anemic since the downturn.

While utilities are offsetting weak demand through other growth initiatives, including rate-basing infrastructure upgrades and adding new regulated earnings streams through acquisitions, their core business is still ultimately beholden to load growth.

And the sluggish U.S. economy doesn't look like it's about to give electricity demand a boost anytime soon. Meanwhile, rising efficiency and the secular shift to a service economy are slowly eroding existing demand.

One possible answer to this conundrum: electric cars. As plug-in cars become increasingly affordable, they could spur greater electricity demand and help justify premium valuations for utilities.

In fact, according to an influential annual survey conducted by veteran utility banker Lewis Hart, Wall Street executives believe the electric-vehicle market has strong potential for driving utilities' future earnings growth.

That would be a welcome development, indeed, since some analysts are fretting that utilities might otherwise go from enduring weak electricity demand to suffering an absolute decline in kilowatt-hour sales.

At Utility Forecaster, we've been acutely aware of weak electricity demand and have, therefore, focused on investing in utilities that operate in service territories underpinned by strong economies. But with a handful of exceptions, a relatively strong state economy in this environment means gross domestic product (GDP) growth that ranges between 2% and 3% - that's hardly gangbusters.

So for the past few years, we've been closely monitoring the prospect of electric cars boosting electricity sales. Of course, the stodgy utilities industry is typically slow to adapt to changing technology. The sector's huge infrastructure and enormous capital expenditures make it difficult to turn on a dime.

But the industry is starting to take the opportunity more seriously. Nearly two years ago, the Edison Electric Institute, the association that represents investor-owned utilities, published a report encouraging utilities to begin electrifying their service-vehicle fleets. Baby steps.

And the fact that Wall Street financiers now see this technology as a potential source of future demand growth could be the impetus the industry needs to truly make gains in the electric-vehicle markets. After all, these are the guys with all the capital, and this survey suggests they would smile upon the opportunity to deploy more capital to this endeavor.

As the utility-sector specialist Leonard Hyman recently observed:

"Wall Streeters don't produce the electricity. But they do determine the cost and availability of capital for the most capital intensive of industries, and Wall Street can change corporate direction with a disapproving phone call or an encouraging report. They have enormous influence and invest both time and money to stay ahead of the curve."

Of course, I have long believed that electric cars are the best option to increase electric-demand sales, as well as help reduce carbon emissions. When I was a strategy executive at Dominion Resources Inc. (NYSE: D) many years ago, our team did the analysis that showed that electric cars could increase demand while making more efficient use of the electric system.

Even so, there are still significant cultural and regulatory hurdles that many utilities will have to overcome before they can truly benefit from this trend.

And at present, electric utilities have yet to develop the business model necessary to capitalize on the electric-vehicle market.

But we will continue to watch this space closely, as this could be a significant investment opportunity. Because the utility that successfully transforms its business to serve the transportation sector could very well one day outpace its peers in earnings growth, and set a new standard for excellence in the industry.

For my part, I've always been a fan of Porsche's 918 Spyder hybrid-electric sports car. But the salesman on the showroom floor admonished me to look, but don't touch: The price tag is a mere $847,000.

So until a Russian oligarch takes me under his wing (and my local utility makes charging at my house more convenient), I'll have to admire it from afar. Such are the pricing and infrastructure challenges for the automobile and electric utility industries.

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