Warm Temperatures Turn Utilities Into Hot Investments

The searing temperatures that have made this one of the hottest summers in memory are also making electric utilities one of the better investments in what Federal Reserve Chairman Ben Bernanke termed an "unusually uncertain" economic environment. The combination of increased revenue from residents and businesses keeping cool during summer's dog days and the prospect of increased electricity use that comes with a sustained economic recovery bode well for electric utility stocks for the remainder of 2010 and into 2011.

The National Oceanic and Atmospheric Administration reported that the U.S. experienced its eighth-warmest June on record, and July has brought even hotter temperatures. With summer being the high season for electrical use, demand for power to cool residences and businesses increases sharply, and so do utility revenues. Analysts say that as long as temperatures stay hot, electric utilities are certain to benefit.

Estimates Raised

"Early in the spring, our expectation for industry revenue was flat to marginally down, but with the heat and the slow but steady increase from commercial demand as well, that early estimate is probably going to have to be raised as we go through the rest of the year," said George Van Horn, senior analyst for IBISWorld.

Van Horn said that since many utilities serve large customer bases over huge geographic footprints, the increased demand from consumers will drive their revenues higher over the short term. He said it would be difficult to determine how much higher revenues could rise because temperatures and energy prices vary by region and no one can predict how long the national heat wave will last. However the impact has already been felt during this earnings season.

"We are seeing companies report second quarter results that include nice boosts, especially to the consumer sector, directly related to higher than normal temperatures," said Van Horn.

For example, when Dominion Resources (D) reported second quarter earnings on Wednesday, Thomas Farrell II, its chairman, president and chief executive officer said in a statement: "Our core business continued to deliver solid results in the second quarter. Coupled with the benefit of hot weather in our electric service territory, we are able to report second-quarter operating earnings well above expectations."

Additionally, Zack's Equity Research reported that Southern Company (SO) enjoyed increased residential use due to warmer temperatures which helped offset maintenance and other expenses that were dragging down its performance in the second quarter.

Analysts at Morningstar note that second quarter revenues typically account for just 20% of a utilities annual profits, but the sustained high temperatures have boosted profits significantly. Morningstar expects the hot weather to drive above-consensus revenues and impressive year-over-year earnings for Dominion, American Electric Power (AEP), Northeast Utilities (NU), NSTAR (NST), Public Service Enterprise Group (PEG), PPL (PPL), FirstEnergy (FE), DPL (DPL) and Pepco Holdings (POM).

Recovery Will Also Boost Utilities

While the hot temperatures have produced short-term gains for utilities, another factor that could make utilities a good investment for the rest of the year and into 2011 is the long-awaited economic recovery. Utility executives are reporting industry demand is showing only marginal increases over 2009, the lowest level of power usage since 2004, but analysts expect revenues for the industry to surge once manufacturers begin ramping-up production.

Richard Soultanian, co-president of NUS Consulting, an energy cost advisory firm, estimates that the U.S. manufacturing sector is only operating at 70% capacity, largely due to the global economic slowdown over the last few years. He believes that electricity usage in the U.S. will increase as the current recovery picks up steam. That will mean another boost for utility companies that could lift their stock prices.

"If the economy starts to rebound in a more robust way, I think rates are going to jump up significantly," said Soultanian. "We are sort of in the lull before the storm."

Soultanian projects that electricity prices are going to remain stable over the next six months. However, once economic activity takes hold and starts to build in a sustainable way, long-term growth could be possible for the best run utilities. Electric utilities in manufacturing centers stand to benefit the most by a recovery in full swing.