Friday, April 6, 2001 Electroshock in California, Part Deux

Pacific Gas and Electric files for bankruptcy, dragging down all the California utilities. Plus: updates on the economy and Phelps Dodge. By Michael Sivy

It's hard to believe that the governor of a major state would stand around with his thumb in his ear while the state's power system unravels. But California's Gray Davis seems perfectly willing to do so. Since I wrote about the California power crisis in December (see "Electroshock in California," the situation has only deteriorated, and the consequences for California utility stocks have been catastrophic. At the time of my last column, Edison International, parent of Southern California Edison, and PG&E, parent of Pacific Gas and Electric, were down more than 25 percent from their highs. Since then, PG&E has lost more than two-thirds of its remaining value, culminating in Friday's bankruptcy filing. And Edison has been dragged down as well, losing almost 50 percent.

I don't expect the situation to improve any time soon. The California electric companies are responsible for part of the problem. They enthusiastically agreed to a plan for deregulating electricity that looks pretty stupid in retrospect. But the bigger problem is California liberalism. Environmentalists have relentlessly opposed the construction of new power plants, unions have held up projects for more money, and consumers have loudly opposed rate increases. As a result, over the past decade generating capacity has totally failed to keep up with growth in the California economy. The children of the Golden State seem to believe that other people should provide them with electricity. And Governor Davis doesn't plan to disabuse his constituents of that notion.

But even if investors steer clear of the California utilities, they still have to decide what to do about out-of-state utilities that sell power in California. I've long recommended Duke Energy, first at $31 last summer (adjusted for a subsequent 2-for-1 split) and then again at $43 in December. Since then, Duke has been choppy, and the stock sold off to $40 on news of PG&E's bankruptcy filing. California utilities owe Duke more than $100 million for power they've bought, and now there's no telling how much Duke will be able to collect. In addition, out-of-state power suppliers are natural targets for California politicians looking for scapegoats.

But whatever collateral damage Duke may suffer in the next few months, its strategic position will only get stronger. The plain fact is that California doesn't have enough electricity and there's no one with enough spare power to make up the shortfall. So the few companies that can provide extra power to California will enjoy a seller's market, even if they're resented and vilified. I'd certainly continue to hold Duke if I had gains and I'd be willing to buy on any dips. With double-digit earnings growth and a 2.5 percent yield, Duke is fairly priced at 18 times this year's estimated earnings.

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Friday's employment report was worse than expected, showing a loss of 86,000 jobs in March. In recent columns, I've made much of the fact that employment has continued growing -- and that therefore we couldn't be in a recession. This employment report signals that the downturn may get worse than I expected. The bad news is that second-quarter earnings will be lousy -- so the bear market could continue for at least another two or three months. The good news is that the Federal Reserve is very likely to cut interest rates again, which should lead to a pick-up by the end of the year. You can expect another half point cut at the May 15 Fed meeting, if not before.

http://www.money.com/money/depts/investing/sivy/archive/010406.html

-- Martin Thompson (mthom1927@aol.com), April 09, 2001