Citing a 34% average increase on year-to-date share priceswithin the U.S. electric power industry, Deutsche Banc Alex. Brownanalyst James Dobson initiated a watch of 18 generation and 15distribution companies in the firm’s U.S Electric Power Industryreport last week. The analyst and his associates also released alist of likely takeover candidates within the industry, and whichenergy companies’ subsidiaries are ripe for initial publicofferings (IPO) in 2001.

“The electric power sector has been a very strong performer yearto date in 2000 as a result of the recognition of the shortage ofgenerating capacity, improving fundamentals, rising electricityprices and concerns about the broad market, which has bred adefensive bias in the marketplace,” the firm stated.

Of the 33 companies included in the coverage group, Dobsonrecommended AES Corp., Calpine Corp., Exelon Corp. and ReliantEnergy as “strong buys,” and Allegheny Energy, ConstellationEnergy, CMS Energy and UtiliCorp United as “buys” among generators.Dobson also tapped El Paso Electric and Niagara Mohawk as “buys”among distributor companies.

Deutsche Banc divided the electric power industry into generatorand distributor sub-sectors because generators are currentlyoutperforming distributors in 2000. Dobson recommends “selectiveexposure” to the industry because the infrastructure is stilldeveloping as the fundamentals of the sector continue to evolve andimprove, particularly for generators. He expects that the positivemomentum in the group of selected companies will continue.

“In our view, the generators over the next few years stand torealize significant earnings growth through the additions of newgenerating capacity and the stability of electricity pricing,” saidDobson. “On the other hand, the distributors face the challenge ofthe uncertainty of deregulation, the potential for market sharelosses and the risk of spiking prices in the near to intermediateterm. However, the distributors should benefit in the long termfrom the capacity additions, which will likely stabilize or reduceelectricity prices.”

With over 20 states passing electricity deregulation legislationalready, the analyst believes that deregulated marketplaces offersgreat opportunities, but believes difficult deregulationexperiences such as the one California is coping with will slowdown electric choice development in 2001 by other states. Still,positive electric deregulation in states like Pennsylvania and NewJersey make back-pedaling into full regulation extremely remote,the firm said.

Due to supply shortages witnessed by California this summer,Deutsche Banc believes that to build and maintain a 15% reservemargin nationally, the country has to add over 100,000 MW of newgenerating capacity over the next five years. At $550 million pergigawatt of capacity, the firm estimates that over $50 billiondollars needs to be invested over the next five years whichanalysts believe will lead to a strong return.

“In light of the earnings growth prospects of the generators, wecontinue to argue that investors are well advised to overweight thegenerators relative to the distributors,” the firm said in itsreport. “With generators trading at around 14 times our 2001estimates and distributors trading at around 11 times, we believethe absolute and relative valuation case continues to argue infavor of the generators. However, we would either buy the highestquality names with additional acceleration or upside surprisepotential or try to buy the names that represent better value inthe generation sector, but that possess the potential to createadditional value prospectively.” Dobson expects earnings growthover the next few years to average approximately 5% fordistributors, and 15% for generators.

The firm also expects merger activity to continue at currentspeed. With 59 mergers taking place within the electric powerindustry since 1995, Deutsche Banc believes further merger activityin the electric industry is positive and inevitable. The firmbelieves the following company’s are likely takeover candidates: CHEnergy; Cinergy Corp.; Cleco Corp.; CMS Energy; Conectiv; DPL; ElPaso Electric; Energy East; Nstar; Pinnacle West; Potomac Electric;SCANA Corp.; Sierra Pacific; UtiliCorp United and WPS Resources.

Deutsche Banc also predicts that the trend of IPOs byunregulated generation subsidiaries will continue in 2001. AfterSouthern Co. issued stock in Southern Energy, and Xcel Energyissued stock in NRG Energy, the firm believes others will attemptto reap added value by issuing IPOs for their generationsubsidiaries. Constellation Energy and Reliant Energy have alreadyannounced similar IPO plans for early 2001. Other candidatesinclude: Allegheny Energy; American Electric Power,; Duke Energy;Edison International; Entergy Corp.; Exelon Corp.; FPL Corp.;PG&E Corp.; PPL Corp.; Public Service Enterprise Group andUtiliCorp United.

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