Falling interest rates and low inflation have been an unbeatable combination for area utility companies, and during the last two years the favorable climate has boosted the price of their stocks by an average of 48.5 percent.
Potomac Electric Power Co. stock soared 52.5 percent, Dominion Resources moved up 51.7 percent, Baltimore Gas & Electric grew by 50.4 percent and Washington Gas Light Co. gained by 39.5 percent.
With interest rates still dropping, and falling oil prices putting a new lock on inflation, the stocks of all four companies bounced up again last week. Pepco closed at $38.25, Dominion Resources at $37.63, BG&E at $25.75 and Washington Gas at $22.25.
Utility stocks traditionally have been regarded as fixed-income holdings, bought by investors for their safety and dependable dividends. That still is true of the four utilities in this region, although electric companies elsewhere encountered severe financial difficulty when they tried to get into the nuclear power business.
Securities industry analysts who follow electric utilities highly rate Pepco, Dominion Resources and BG&E for several reasons. But the key reason is that the local companies do not have what the analysts call "nuclear exposure."
Pepco has no nuclear plants and Dominion Resources and BG&E built theirs before costs got out of hand.
"These companies essentially sell on yield," said Steven A. Parla, gas industry analyst at Goldman, Sachs Inc., who follows Washington Gas Light. WGL yields about 7.8 percent. As interest rates trend down, and the returns on competing money market funds and certificates of deposit fall, "this type of investment becomes more and more attractive," he said.
Dominion Resources offers the highest yield among this group of stocks, yielding 7.7 percent, which also happens to be the national average. BG&E offers 6.8 percent while Pepco has a 6.4 percent yield.
The tie to interest rates is very close. If interest rates were to fall another 2 percent, Parla said, the utilities would be "fantastic investments." On the other hand, he said, if interest rates were to rise 2 percent, the utilities' momentum "could stall."
Thomas P. Halligan, group vice president at Duff & Phelps, a Chicago investment firm, looks at a combination of current yield and expected dividend growth to make his judgments on utility stocks. Thus, he sees Pepco as offering a return of 14 percent, BG&E 12 percent and Dominion Resources about 13 percent. The average for the utilities he follows is about 12.5 percent, he said.
The local utilities have known tough times and those days could return if inflation heated up, if interest rates turned around or if the companies had to get into costly new building programs. All "ifs" aside, these are the salad days for the utilities.
Even the drop in oil prices appears likely to have a favorable impact on the electric stocks. It's not because the utilities buy or burn much oil. They don't. But downward pressure on oil means downward pressure on all fuels, analysts say. Coal, which is the fuel most of the utility companies burn, still is considerably cheaper than oil but the new competition may prove significant.
From the standpoint of WGL, however, the oil-price drop could present a problem. WGL has a number of customers who can switch easily from gas to oil, if the price is right. WGL officials say they are working to meet the competition.
The changing economic and investment climate of the last few years has changed the utility company image. As their shares move upward, they have begun to resemble growth stocks, attracting investors interested in total return: price growth plus dividends.
In that category, the total return picture has been impressive, according to figures by Duff & Phelps. Total return for Pepco was 45.7 percent in 1985, 24.3 percent in 1984 and 29.6 percent in 1983. Dominion Resources had 32.5 percent in 1985, 42.3 percent in 1984 and 16.8 percent in 1983. BG&E had 31.2 percent in 1985, 38.1 percent in 1984 and 20.0 percent in 1983.
WGL returned 30.7 percent in 1985, 28.4 percent in 1984 and 32.8 percent in 1983, said Robert P. Burcham, WGL's director of financial analysis.
The impact of the changing climate especially is evident in the case of Pepco, whose stock sold at $12.38 on Jan. 2, 1981. It closed Dec. 31, 1985, at $34.63, an increase of 179.8 percent or 22.9 percent a year compounded. With dividends included, the total return was 319.2 percent or 33.2 percent a year compounded.
James S. Culp, Pepco's vice president for investor relations, who provided the figures, pointed out that performance measurements depend on the time period you look at. While these are upbeat times for Pepco stockholders, there also have been some bad patches. For instance, Pepco had a total return of minus 5.65 percent in 1979 and minus 4.98 percent in 1978. Those were the days of high inflation and high interest rates.
Electric utilities analyst Barry M. Abramson of Prudential-Bache said that, compared with the universe of utility stocks, Pepco, Dominion Resources and BG&E are sitting in the cat bird's seat because they operate in strong economic areas, have high quality earnings, minimum capital spending demands and no major nuclear problems.
Other utilities, he noted, are not so fortunate, and institutional investors, who handle billions of dollars in pension and other funds, are shying away from utilities with expensive, unfinished or nonworking nuclear plants.
Prudential-Bache rates companies on a number basis. A rating of 1 means "strong buy," a 2 means "buy" and a 3 means "hold." They also apply these ratings to both a short-term basis and a long-term basis. Thus a 1-1 rating means a "strong buy" for both short term and long term.
Dominion Resources has a 1 and 2 rating. Pepco is rated 2 and 1 and BG&E is rated 3 and 2.
Mark D. Luftig, electric utility analyst for Salomon Bros., is a bit more favorable to BG&E at the moment but has put BG&E, Pepco and Dominion Resources in the group of utilities he considers least risky.
All three electric utilities have developed plans for capturing income from nonutility sources. Pepco, BG&E and Dominion Resources have organized investment operations that permit them to go beyond traditional utility investments, including satellite and airplane leasing.
Pepco attributes 32 cents of its $3.59 a share earnings in 1985 to its investment arm while BG&E drew 14 cents of its $2.80 in 1985 earnings from similar sources. A Dominion Resources investment group is just getting under way.
Speaking of profits, Pepco earned $3.23 a share in 1984 and $3.59 in 1985, with analysts looking for about $3.80 in 1986. Dominion earned $3.46 in 1984, $3.60 in 1985 and estimates run to about $3.80 for 1986. BG&E, which provides both electric and gas service, saw its $2.77 a share profits in 1984, rise to only $2.80 in 1985, with about $2.90 expected for 1986.
WGL profits also flattened out with $2.45 a share in 1984 and $2.46 in 1985. Estimates for 1986 are about $2.50, although this may turn out to be high if the weather remains warmer than usual.
BG&E and WGL cited warm weather last winter as the reason for flat earnings. "We didn't get the sales we expected," said Edward A. Crooke, chief financial officer at BG&E. Pat Maher, executive vice president for finance at WGL, said the weather was 2.5 percent warmer in 1985 than in 1984.
Price earnings ratios run reasonably close together. Dominion Resources and Pepco sell at 10.3 times earnings, BG&E at 9.4 times and WGL at 9 times.
Pepco's Culp remembers when most of his company's stockholders were individuals. That's not so any longer. All four utilities have become favorites of the big institutions. BG&E stock is owned by 232 institutons who hold 36.6 percent of its shares. Dominion Resources has 26.3 percent of its shares owned by 267 institutions. Pepco has 175 institutional investors holding 24 percent of its stock. WGL has 57 institutional investors holding 23.9 percent of its shares.
The institutions' role is no surprise. Because of the huge amounts of money they can invest, they have quick access to the best and most timely research available. Pinpointing the potential of the Washington, Baltimore and Richmond utilities probably was one of the easier choices they made.