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Deutsche Banc Picks Top 2001 Power Firms; Mergers to Continue

Deutsche Banc Picks Top 2001 Power Firms; Mergers to Continue

Citing a 34% average increase on year-to-date share prices within the U.S. electric power industry, Deutsche Banc Alex. Brown analyst James Dobson initiated a watch of 18 generation and 15 distribution companies in the firm's U.S Electric Power Industry report last week. The analyst and his associates also released a list of likely takeover candidates within the industry, and which energy companies' subsidiaries are ripe for initial public offerings (IPO) in 2001.

"The electric power sector has been a very strong performer year to date in 2000 as a result of the recognition of the shortage of generating capacity, improving fundamentals, rising electricity prices and concerns about the broad market, which has bred a defensive bias in the marketplace," the firm stated.

Of the 33 companies included in the coverage group, Dobson recommended AES Corp., Calpine Corp., Exelon Corp. and Reliant Energy as "strong buys," and Allegheny Energy, Constellation Energy, 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 generator and distributor sub-sectors because generators are currently outperforming distributors in 2000. Dobson recommends "selective exposure" to the industry because the infrastructure is still developing as the fundamentals of the sector continue to evolve and improve, particularly for generators. He expects that the positive momentum in the group of selected companies will continue.

"In our view, the generators over the next few years stand to realize significant earnings growth through the additions of new generating capacity and the stability of electricity pricing," said Dobson. "On the other hand, the distributors face the challenge of the uncertainty of deregulation, the potential for market share losses and the risk of spiking prices in the near to intermediate term. However, the distributors should benefit in the long term from the capacity additions, which will likely stabilize or reduce electricity prices."

With over 20 states passing electricity deregulation legislation already, the analyst believes that deregulated marketplaces offers great opportunities, but believes difficult deregulation experiences such as the one California is coping with will slow down electric choice development in 2001 by other states. Still, positive electric deregulation in states like Pennsylvania and New Jersey 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% reserve margin nationally, the country has to add over 100,000 MW of new generating capacity over the next five years. At $550 million per gigawatt of capacity, the firm estimates that over $50 billion dollars needs to be invested over the next five years which analysts believe will lead to a strong return.

"In light of the earnings growth prospects of the generators, we continue to argue that investors are well advised to overweight the generators relative to the distributors," the firm said in its report. "With generators trading at around 14 times our 2001 estimates and distributors trading at around 11 times, we believe the absolute and relative valuation case continues to argue in favor of the generators. However, we would either buy the highest quality names with additional acceleration or upside surprise potential or try to buy the names that represent better value in the generation sector, but that possess the potential to create additional value prospectively." Dobson expects earnings growth over the next few years to average approximately 5% for distributors, and 15% for generators.

The firm also expects merger activity to continue at current speed. With 59 mergers taking place within the electric power industry since 1995, Deutsche Banc believes further merger activity in the electric industry is positive and inevitable. The firm believes the following company's are likely takeover candidates: CH Energy; Cinergy Corp.; Cleco Corp.; CMS Energy; Conectiv; DPL; El Paso 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 by unregulated generation subsidiaries will continue in 2001. After Southern Co. issued stock in Southern Energy, and Xcel Energy issued stock in NRG Energy, the firm believes others will attempt to reap added value by issuing IPOs for their generation subsidiaries. Constellation Energy and Reliant Energy have already announced similar IPO plans for early 2001. Other candidates include: Allegheny Energy; American Electric Power,; Duke Energy; Edison International; Entergy Corp.; Exelon Corp.; FPL Corp.; PG&E Corp.; PPL Corp.; Public Service Enterprise Group and UtiliCorp United.

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