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Deregulation a live wire in electric-utility industry

Posted online

by Jack Lantis

for the Business Journal

For years, utilities have long been considered a "core" investment for a conservative portfolio. However, deregulation is changing the landscape of the electric-utility industry, bringing about increased competition for prices and geographic boundaries at the business and consumer levels.

With these changes and increased competition, you may need to carefully evaluate your investments in this industry.

Historically, the electric-utility industry has consisted of vertically integrated local monopolies. However, the power-generation segment of the business is opening up to competition, increasing risk but also expanding opportunities for the power-generation market.

As a result of these changes, you may need to be more selective when choosing utility stocks. First and foremost, you need to determine what your goals are for investing in utilities.

Deregulation could bring some short-term changes to what were once considered conservatively based reasons to invest in utilities steady dividend growth and increased earnings potential.

However, the days of security may be no more for the electric-utility industry. Potential changes in the landscape of the electric-utility industry include:

?Decreased earnings growth. There are several factors that influence a utility company's earnings growth, including the cost of doing business, regulators, its senior management team and the company's balance-sheet strength.

Because deregulation will bring competition to a monopoly business, some companies may experience earnings declines.

?Dividend changes. For years, utilities were appealing to investors because their dividends typically increase every year. However, slowed earnings growth and the potential for declining profit margins resulting from competition is prompting some companies to either forego increasing their dividends or, in some extreme cases, reduce current dividend payouts.

?Stranded costs. As the power-generation segment of the utility business opens itself up to competition, consumer prices of power generation will be set by market forces, not regulators, as has been the case in the past.

These new prices for electricity might be too low for some electric utilities to completely recover their fixed and variable costs for producing the power, not to mention earn a profit. These above-market generating and purchased-power costs are called "stranded costs."

To the degree that such stranded costs are not allowed recovery through customer rates, some electric-utility companies may face downward pressure on earnings.

The changes in the power industry should cause you to take a serious look at the appropriateness of investing in utility stocks. The age-old reasons for investing in power industry stocks stability, increased earnings- and dividend-growth potential are no longer industry-wide traits.

However, there are select utilities with strong competitive positions, good earnings and growth potential that can be considered attractive investment opportunities.

Conservative portfolios should choose carefully when buying utility stocks,

or consider other conservative investments.

While it is now time to be selective in the utility industry, your investment professional can help you determine whether you need to pull the plug on your existing utility investments.

(Jack Lantis is an investment broker with A.G. Edwards & Sons Inc. in Springfield.)

INSET CAPTION:

Because deregulation will bring competition to a monopoly business, some companies may experience earnings declines.[[In-content Ad]]

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