In blackout aftermath, one stock shines bright
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If you believe that the U.S. power infrastructure is finally in line for its urgently needed upgrade, you have to believe in the shares of Quanta Services.
By Jon D. Markman
The nation’s electrical grid is a doddering, abused, nearly penniless old man in his 80s, limping around with bad knees and a bad heart, whose survival at this point is a miracle of occasional emergency-room medicine.
The paralyzing blackout last month in the Midwest and Northeast came as no surprise to this invalid’s nursing-home minders -- the executives of power companies charged with keeping him alive as long as possible without the benefit of much aid from the state and federal politicians, regulators and citizens responsible for paying the bills.
The electricity industry has been pleading with Congress and state legislatures for years to supply the money required to bring the nation’s power infrastructure up to developed-world standards, only to be faced down at every turn by anti-tax militants and NIMBYs more interested in personal agendas than the national good.Money 2004.
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If anti-growth lobbyists were inconvenienced enough during the blackout by not having refrigerated milk for their granola, then the political will might finally emerge to coax higher tariffs and rate increases from voters when governments reconvene after the summer. And then we might see some of the estimated $27 billion in backlogged electrical infrastructure projects finally assigned to the power construction companies. Add to that, experts say, another $100 billion to $200 billion or so to modernize the U.S. grid to the level of Norway or Ecuador, and you have a real investment opportunity in the wings.
Only one true blackout play
The leader in the construction of transmission and distribution lines, by an order of magnitude, is Quanta Services (PWR, news, msgs). Run by John Colson out of Houston, Quanta is the result of about 85 acquisitions, or roll-ups, of small power construction companies nationwide. After going public in 1997, it has grown annual revenue from the $100 million range to around $1.7 billion. It competes in every part of the United States, mostly against local yokels with pickup trucks, and has a number of patented technologies that allow its crews to work on power lines even when they’re energized -- a neat feat that saves utilities a lot of money.
I first mentioned Quanta in July last year in a column about companies that were so ridiculously cheap and undervalued that they might attract interest from leveraged buyout firms. Because Quanta had prospered during the telecom boom years by expanding into telephone, fiber-optic and cable infrastructure work, its shares had crashed along with tech stocks and were fetching just $2.25.
With the modest revival of interest in telecom spending, and now the real prospect of new electrical grid spending, Quanta’s shares have recently powered up to around $9.60 -- a level at which they’re fairly priced. Momentum could take shares far beyond fair value in the next few months, to be sure. But when the blackout headlines are replaced with other news, the stock could back off to its pre-blackout price of $7, where it should be a good prospect for growth investors. “If you want to capitalize on the rebuilding of our transmission and distribution infrastructure,” says First Albany research analyst Sanjay Shrestha, “you definitely want to put this stock on your screen.”
Rebuild today or cope tomorrow
How much work needs to be done? Consider the historical perspective. In the 1920s, when the electric grid was being built, 35% of electricity revenues were plowed back into construction; in the 1930s, 30%; in the 1940s, 22%; in the 1950s, 20%; in the 1960s, 17%; in the 1970s, 16%; in the 1980s, 5% and in the 1990s, 4%. These numbers illustrate not just how much the infrastructure has been neglected, but how old it is. It is not just sick and tired, it's an antique.
Moreover, each part of the grid was originally designed by individual utilities to move electricity from generation plants to their own users; the idea of tying out to a neighboring utility for backup was of minimal concern. As consumers have integrated power into more of their daily lives -- switching, for instance, from gas to electric stoves, or from phone calls to e-mail -- utilities have tried to patch the network more closely together. But the national grid is much more like a bunch of little local roads connected with wooden bridges than it is the national interstate highway system.
Of course, the electricity situation isn't static, either. Demand is expected to grow 32% by 2020, tracking the continuing demographic shift of rural folks and immigrants to cities, as well as the emigration from highly populated and electrified Northern states to the currently less populous and thus less adequately served Southwest. Without an increase in grid investment, blackouts like the one this summer will become a regular occurrence.
In a capitalist utopia, investment would follow demand. But the world of electricity is driven by everything but market forces, as utilities must beg bureaucrats for the sort of rate increases that would offer a reasonable return on their money. The big question before utilities today is whether to build now and hope that higher rates on new lines will be grandfathered in, or hold off and ensure that higher rates of return are guaranteed. Where there is uncertainty, few are brave enough to wade in -- and inertia rules.
What to watch
A break to the impasse could come as soon as this month, when Congress is expected to begin final debate on a controversial energy bill that includes federal eminent domain language grid-builders covet; the new rule would help utilities open up more space for power lines. Rep. Billy Tauzin, a Louisiana Republican and chairman of the House Energy Committee, has told reporters he wants to have the bill ready for the president to sign by the end of September. Don’t hold your breath, however, since the White House has insisted that the final bill open the Arctic National Wildlife Refuge to oil drilling, and Democrats have vowed to filibuster if it does.
If new laws and ratepayer money ever do get shaken loose, then significant grid reconstruction should start flowing to companies like Quanta by the middle of next year or the start of 2005. Quanta would be highly leveraged to that, as it gets 62% of its revenues from electricity and gas transmission construction. Not including a one-time charge in the last quarter, the company is nicely profitable -- targeting 12% net margins.
The P/E multiple is a bit high right now, around 25 if you exclude that charge, but it reflects a trough of depressed earnings. The price/sales multiple is meager at 0.64 and the price/book multiple is 1.56 -- about in the middle of its historic range. The company has been paying down debt, and it now amounts to a manageable $385 million for a debt/equity multiple of 0.57. Shrestha, the First Albany analyst, has a $10 price target on the stock, reflecting a 20 P/E multiple on projected fiscal 2005 earnings per share of 50 cents.advertisement
As you can see, the stock is not exactly a raging value at this time. But it pays to plan. If the market skids this fall, and if it looks like the politicians will trade talk for action, then Quanta could become one of those real rarities: a decent five-year hold.
There are really no other direct plays on grid reconstruction, since Quanta’s major competitors -- heavy construction firms MasTec (MTZ, news, msgs) and Dycom Industries (DY, news, msgs) -- focus more on cable and telecom than on power. A side bet, however, could be made on American Superconductor (AMSC, news, msgs) or Intermagnetics General (IMGC, news, msgs), which make superconducting cables that are likely to be built into new projects. Power lines made from supercooled nickel- or silver-based materials have the potential to transmit seven to eight times more electricity than copper-based lines. Their stocks are too hot to touch right now, but check back in a few weeks or months and try to buy at pre-blackout prices, which were $3.50 and $16, respectively.
Fine Print
Learn more about Quanta here. The company’s customer list spans the country. This page explains how Quanta works as a construction outsourcer for various utilities . . . Learn about American Superconductor here . . . Learn about Intermagnetics here . . . U.S. Treasury Secretary John Snow is heading to China this week. He will try to avoid talking explicitly about the value of the Chinese currency, but he won’t be able avoid the controversy, as explained in my July 30 column. Watch for the export of manufacturing jobs to become a major campaign issue in the upcoming presidential election . . . The five-stock Flare-Out Growth portfolio proposed in my Aug. 20 column didn’t waste any time getting on track. It was up 5.9% through Aug. 28, vs. a 0.1% rise in the S&P 500 Index. The leaders are Primus Telecommunications (PRTL, news, msgs) and Westell Technologies (WSTL, news, msgs) . . . The latest S&P 500 kick-out trade has gone off like clockwork. McDermott International (MDR, news, msgs) has risen 19% since being booted from the big-cap index on Aug. 19, while its replacement, Medco Health Solutions (MHS, news, msgs), is up only 5%. (See reference in the Fine Print of my Aug. 20 column here.)
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jmarkman@oddpost.com. At the time of publication, he had no positions in stocks mentioned in this column.
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