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Home Learning Study materials video Std 12 DD Girnar/Diksha portal video https://diksha.gov.in/
It’s a tricky time to be a utility investor. But tricky times can make for good investments.

Utilities are best known for producin reliable dividends for income-hungry investors in the best and worst of times. That assumption has been upended by the coronavirus, as investors worry about reduced electricity use by businesses and missed payments by unemployed workers. As a result, they’ve instead flocked to technology, consumer staples, and other sectors that make stay-at-home life more bearable.

And therein lies the opportunity. Although utilities have fallen out of favor, with the stocks down 3.3% since the end of May, conditions are still favorable for the group. Interest rates are low, adding to the appeal of their dividends, while the stocks appear to be oversold, based on technical levels.

The attraction hasn’t been lost on at least one prominent hedge fund, Paul Singer’s Elliott Management, which has made several utility investments in the past three years, taking stakes most recently in Kansas City-based Evergy (ticker: EVRG) and Houston-headquartered CenterPoint Energy (CNP).

The Utilities Select Sector SPDR exchange-traded fund (XLU) is down nearly 11% this year, compared with a drop of 3.6% in the S&P 500 index. Utilities fell further than the broad market from its February peak to its March trough, and have recovered more slowly since then.

What’s more, the sector has been unusually volatile this year, following a “surge then pause” pattern, with less than 60% of utilities able to move above their 200-day moving average—a technical indicator that measures whether a stock is in a longer-term up- or downtrend. Some 35% of utilities are trading below their 50-day moving average, a short-term measure of weakness.

“A lot of structural things [in the utility sector] require regulatory approval. It’s often a 12-to-24- month process. ”— Neil Kalton, managing director at Wells Fargo Securities

The good news: In the six months after stretches of volatility like this year’s, the sector historically has averaged a 9.3% gain, observes Jason Goepfert, president of Sundial Capital Research. “This kind of activity hasn’t been enjoyable for investors in the short term, with highly volatile swings in utilities,” he writes. “For those that held out, though, the sector tended to recover strongly.”

In April, Barron’s wrote a story arguing that the stocks of regulated utilities had been punished too much in the initial selloff, given the safety of their payouts and the stability of their businesses. Since then, the Utility Sector ETF has dropped by 5.1%, while the S&P 500 has climbed by 11.7%. Applying an activist lens to utility selection could be helpful for investors trying to navigate the tricky space, and Elliott’s recent investments provide near-term catalysts for gains.

Utilities are subject to government regulation, which often dictates how much they can charge customers. As a result, the companies are frequently plagued with inefficiencies that can affect long-term returns—something that makes them attractive to activist hedge funds such as Elliott. Those same regulations, however, can make it difficult for even the hardest-charging activist investors to force change. Just 16% of activist dollars have been deployed in a broad category that includes power, energy, and infrastructure in 2019, according to Lazard data—while industrials and techs have been activists’ most popular plays, attracting 45% of their dollars.

Following in Footsteps
Activist investor Elliott Management has had success with its recent utility investments.

*Returns from trading day prior to announcement through June 30.

Sources: Bloomberg; company reports

“A lot of structural things [in the utility sector] require regulatory approval,” says Neil Kalton, managing director at Wells Fargo Securities. “It’s not as easy as, ‘We’ll do XYZ and get board approval.’ It’s often a 12-to-24- month process. The regulators will often want to make sure that customers benefit, as well.”

“The kinds of complex problems that we encounter often in the regulated utility space require a hands-on approach that is well suited to Elliott’s investment style,” says Jeff Rosenbaum, senior portfolio manager at Elliott. Yet Elliott has found success in this sector. After investing in NRG Energy (NRG) in 2017, for instance, it got the company to sell assets that netted $2.8 billion in cash and to offload $7 billion in debt.

When Elliott invests in utilities, investors can expect deal making to follow. The hedge fund favors a back-to-basics approach, meaning that the target will often be pushed to dump noncore, underperforming assets. Elliott also believes that larger utilities, when focused on the right businesses, drive better shareholder returns, so one can assume the utility will be sold to a bigger company. Both moves can be a boon to shareholders and even customers, who might see lower bills. To win, Elliott must satisfy needs of companies, their employees, regulators, and customers. “We think our experience working constructively with utility management teams and boards over the years gives us an advantage in knowing how to craft these solutions,” Rosenbaum tells Barron’s.

Since 2017, Elliott’s investments in Sempra Energy (SRE), FirstEnergy (FE), and NRG Energy have produced gains ranging from 36% to 93% during the first year of its involvement. That handily beat the Utilities Select Sector SPDR’s advance.

Elliott uses a variety of metrics to determine where to invest. Some, including price/earnings ratios, earnings growth, and dividend yields, are commonly employed across many industries.

But when it comes to utilities, Elliott also examines the company’s total enterprise value against its rate base—the assets on which the utility is permitted to earn a return.

Following a hedge fund into an investment is sometimes impossible—or a fool’s errand. The funds often realize substantial paper gains long before their positions are made public, and few retail investors are quick enough to take advantage of the first-day pop that most stocks see after an activist discloses a new position. Individuals can’t expect to replicate Elliott’s performance, and some of its investments are too risky even for many pros.

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For example, Elliott bought bonds in California’s PG&E (PCG) in 2019, around when the beleaguered electric utility filed for bankruptcy protection following deadly wildfires that were found to be caused by its faulty equipment. The bet was that the securities were trading below recovery values and would revive. It was a volatile ride, but the bonds did recover, and PG&E emerged from bankruptcy this past Wednesday. That’s not a wager that do-it-yourself investors should chase.

Still, individuals can borrow a few pages from the activist’s playbook, even if they invest later. If they had bought the stocks that Elliott invested in when the hedge fund operator’s position became public, they could have made an average single-day gain exceeding 5%.

Elliott’s two most recent plays look as if they’ll have better outcomes—and could provide an ortunity for other investors. Elliott invested in CenterPoint in May, leading a $1.4 billion equity investment alongside Fidelity Management and Bluescape Energy Partners. CenterPoint has $13.8 billion of debt, and the cash was meant to help the company, whose stock had dropped 42% during the previous 12 months, pay that down.

CenterPoint, which serves clients in Texas, Arkansas, and six other states, also formed a committee, at Elliott’s urging, to evaluate strategic options, which could include a partial or full sale; the panel is supposed to report its findings to the board in October. The stock, up 17% since Elliott got involved, recently was trading at $18.67.

Analysts at Morgan Stanley see a “meaningful probability” of a sale of CenterPoint. They say that an acquirer would probably seek to cut costs while boosting capital expenditures and keeping customers’ bills flat.

Evergy might still offer nice returns for investors. Elliott departed from the usual activist script in January, suggesting that the utility curb share buybacks, after Evergy had spent $2.7 billion repurchasing its stock from August 2018 through the first quarter of this year. This was a period in which its shares declined by 2%, versus a 5% gain for the utility ETF.

Elliott found that Evergy would be better off, long term, if it invested in its rate base, rather than doing more buybacks. It concluded that $1 invested could be worth $2.40 to shareholders if the utility would put the money into renewable energy.

Evergy has since formed a committee to review its options as a stand-alone company or as the object of a sale. First-round bids for a sale are expected to be due in early July; the committee’s recommendation on which course to follow is anticipated in August.

Evergy’s stock has fallen by 9.4% since Elliott’s investment became public, while the Utilities Select Sector SPDR’s has slid by 13.5%. But if a deal is struck, Evercore ISI estimates, the shares could sell for as much as $69—13% above Wednesday’s close.

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