Tuesday, July 17, 2012 7:23:07 PM
This chapter deals with utilities, especially nuclear power providers who suffer a temporary setback (like General Public Utilities, once proud owners of Three Mile Island Unit Two), but also other power utilities such as Consolidated Edison, who made massive losses as the price of oil skyrocketed in the 70s energy crisis, and yet regulators refused to allow the company to pass on the price to energy consumers. Although regulators can be a real burden on utilities, they are also their guardian angels, trying to prevent them from going entirely out of business, as long as people still need electricity the government regulators will not allow the company to fold. As a result utilities can take massive hits in the share price, but in all but a very rare few there is a support level from which they bounce back, often very spectacularly several years after the event. Lynch quotes some specialist utility analysts who have identified four distinct stages in a utility crash and recovery.
Stage one: disaster. Either the cost of fuel has gone through the roof or a major accident has occurred, a huge sell off follow, where the utility may fall to 20 to 30 percent of book value in one or two years. Those who regard utilities as safe bottom draw blue chips usually get something of a shock if their once-a-decade examination of their portfolio happens to coincide with this period.
Stage two: crisis management. An austerity budget is adopted and the dividend is reduced or eliminated. Costs are cut to the point that the company can survive the disaster. At this point Wall Street isn't paying attention any more, and stock prices remain very low.
Stage three: financial stabilization. The company, now as lean and mean as it will ever get can now turn a profit on the cash it receives from its bill-paying customers. Share prices by now have doubled, they are selling at 60 to 70% of book value while still reflecting great value in the eyes of typical "value investors".
Stage four: recovery. The company can now once again make a profit and pay a dividend. Shares now sell at full book value. Where it goes from here depends a lot on how regulators allow it to pass on costs to customers and the reception from the capital markets, because the company needs capital to expand.
http://www.rbcpa.com/Lynch's25GoldenRules.html
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