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This wasn’t supposed to happen

Today's Financial News - Posted February 11, 2009

Many investors run to the safety and income potential of utilities when times get tough. It is a good strategy if you play it right. But make the wrong moves and you could pay dearly. Great Plains Energy (NYSE:GXP) investors are learning the hard way today.

By Andrew Snyder, TodaysFinancialNews.com

Baltimore – (TFN): Some investors are learning a very hard lesson today. When investing during a recession, you had better do your homework. If not, your portfolio could be destroyed.

Take a look at Great Plains Energy (NYSE:GXP) and its horrid action. After missing earnings expectations by a country mile and slashing its dividend in half, shares of the company are down by over 20%. Investors are left wondering what in the world just happened. Many did not see it coming.

After all, aren’t utilities supposed to be one of the most conservative, recession-resistant sectors out there?

The answer is yes and no. It depends. Take a look at the chart:

Overall, the Dow Jones Utility Index, with components like Duke Energy (NYSE:DUK) and Dominion Resources (NYSE:D) is solidly beating its Blue Chip brother. But don’t be fooled. The closely monitored index only measures 15 of the most prominent utilities. There are plenty of smaller, much more speculative companies – like Great Plains Energy – waiting to trap unsuspecting investors.

Let’s take a look at Great Plains’ quarterly results and see what is going on amongst the smaller utilities.

Blaming Uncle Sam

Despite a 47% rise in revenues, the company’s bottom line dropped by 86%. A significant change in margins like that is an obvious signal that something has gone awry in the company’s business model. The problem is a common theme in the business world these days… government intervention.

Great Plains, like most utilities, operate in a regulated environment. Unlike companies in a free market, utilities rarely have the luxury of maneuvering prices due to flux in the supply and demand equation. That means, when input prices rise, we get exactly what Great Plains had last quarter, a significant decrease in margins.

This is an important lesson, because the damage caused by pricing regulation is magnified more and more the smaller a utility company is. Mega producers like $19 billion Duke that provide electricity throughout a large chunk of the nation have much more purchasing power over a $1.8 billion provider like Great Plains.

Investors need to consider this when they are making a utility-industry investment. The smaller a produce, the riskier the investment. The dividends may be attractive, but if they are just going to get slashed in half when times get tough, it can really cost your portfolio.

If you are looking towards the safety and income potential of the utility sector, stick with the big guys. The small companies are just as risky, if not more, than the rest of the market. Hopefully you did not learn that lesson the hard way today.


Next Article: Avoid Apartment REITs

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Posted by Andrew Snyder · Filed Under Oil and Energy 

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