Reliably Unreliable Management Teams: Which Utilities Persistently Miss Guidance and Which Beat, and Does It Make a Difference?

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Eric Selmon

Office: +1-646-843-7200

Email: eselmon@ssrllc.com

Hugh Wynne

Office: +1-203.901.1624

Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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October 19, 2016

Reliably Unreliable Management Teams:

Which Utilities Persistently Miss Guidance and Which Beat,

and Does It Make a Difference?

Portfolio Manager’s Summary

  • Our analysis of returns on regulated electric utility stocks shows that over 2005-2015 the annual growth in a utility’s earnings explains just over half the annual variation in its stock returns (see Exhibit 3). It is not surprising, therefore, that analysts should give considerable weight to management’s earnings guidance in estimating returns on individual stocks.
  • In this note, we quantify the historical impact on 12-month stock performance of beating or missing management’s earnings guidance. For each year from 2005 through 2015, we ranked the regulated utilities on the difference between their actual earnings and management’s earnings guidance, as reflected in March 1 consensus estimates. (Earnings guidance is usually released with Q4 earnings during the first two months of the year; by March 1, earnings estimates for the year tend to center on the midpoint of guidance). We then assessed the correlation between utilities’ rankings (lowest rank = biggest miss, highest rank = biggest beat) and their subsequent 12-month stock returns. (See the Methodology section for a fuller explanation of our analysis.)
  • We found the difference between the 12-month stock performance of utilities in the top and bottom half of the distribution (see Exhibit 4) averaged 5.5% over 2005-2015.
  • A much larger gap in one-year stock price performance is evident between the extremes of the distribution. The gap in returns between the five utilities with the largest earnings beats and the five utilities with the largest earnings misses averaged 13.3% over 2005-2015 (Exhibit 5.)
  • In Exhibit 7, we have ranked the utilities by the frequency with which their full year results have met or exceeded March 1 consensus estimates. WEC Energy has met or beat March 1 expectations in each of the last eleven years, and CMS Energy has done so in ten. Meeting or beating expectations in nine of the last eleven years were Edison International, IDACORP, OGE Energy, Public Service Enterprise Group and PNM Resources. At the other end of the spectrum, Hawaiian Electric has failed to meet March 1 consensus estimates in nine of the last eleven years, and Dominion Resources has failed to do so in eight.
  • Edison International has ranked among the five utilities with the largest beat on five occasions over the last eleven years. CenterPoint, Entergy, IDACORP, and OGE Energy have done so on four occasions (see Exhibit 9). Otter Tail has ranked among the five utilities with the largest earnings miss on six occasions over the last eleven years, while Dominion Resources, Great Plains, and Hawaiian Electric have done so on five occasions. (See Exhibit 10.)
  • In Exhibit 10, we ranked the utilities into quintiles based on the accuracy of their guidance. AEP, CMS Energy, Exelon, NextEra Energy, SCANA, Southern Company and Xcel Energy were the most accurate providers of guidance. Avista, Edison International, Great Plains, Hawaiian Electric, OGE Energy, Otter Tail, and PNM Resources were the least accurate, although in the case of Edison International this appears to be solely due to large beats, rather than misses.

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology

Methodology

Our hypothesis is that a company’s failure to meet management’s earnings guidance will be reflected in underperformance relative to the regulated utilities as a group, and that beating guidance will be associated with outperformance. Most regulated electric utilities report full year earnings and give guidance for the following year on their fourth quarter earnings calls, which generally take place from late January until late February. As these earnings guidance ranges are not tracked by electronic data services, we have based our analysis on consensus earnings estimates as of March 1 of each calendar year, reflecting the fact that by March 1 sell-side earnings estimates tend to center on the midpoint of the range of guidance given on the fourth quarter earnings call.

To test our hypothesis, we first calculated the percentage difference between (i) each utility’s consensus earnings estimate on March 1 of each calendar year, and (ii) the actual earnings reported by the utility for the year. We then measured for each utility the 12-month stock price return from March 1 to March 1for each year since March 1, 2005. Finally, we analyzed our data to assess the impact on 12-month stock returns of beating or missing guidance, as well as to identify which utilities most consistently beat or missed their guidance. (For the sake of simplicity, we will refer to March 1 to March 1 periods used in our analysis as the earnings year to which they relate; for example, the period from March 1, 2005 to March 1 2006 will be referred to as 2005.)

To assess the average accuracy of managements’ initial guidance (as reflected in March 1 consensus estimates), we first calculated for each year from 2005 through 2015 the average value of the difference between March 1 consensus and actual earnings; second, we calculated of the absolute values of these averages; and third, we calculated the standard deviation of the differences. As an indicator of the accuracy over time of companies’ initial guidance, we added to the absolute value of the average of the differences one standard deviation of the differences. If the earnings beats or misses formed a normal distribution, approximately two thirds of the observations would fall within a range of one standard deviation on either side of the mean; companies with high average gaps and high standard deviations around the average would thus be the ones offering the least accurate guidance.Details

In this note we examine the impact on returns of utilities’ earnings performance relative to management guidance. We first quantify the historical impact on 12-month stock returns of beating or missing

guidance. We then identify which utilities most consistently meet or beat their guidance and which have most frequently missed it.

Among regulated electric utilities, long-term earnings growth is one of the primary drivers of long-term returns, explaining over 65% of the variation in returns among regulated utility stocks from 2005-2015. As illustrated in Exhibit 2, a regression analysis of the 10-year compound annual growth in EPS for each of the regulated electric utilities vs. the 10-year CAGR in these companies’ stock prices results is an r-squared of 67%. Even when measured on an annual basis, the correlation between earnings and returns remains strong: a regression of annual growth in earnings against annual stock returns results in an r-squared of 51% (see Exhibit 3).

It is not surprising therefore, that analysts should give considerable weight to management’s earnings guidance in estimating returns on individual stocks. Our hypothesis is that a company’s failure meet this guidance will be reflected in underperformance relative to the regulated utilities as a group, and that beating guidance will be associated with outperformance. To the extent this is true, it would be helpful to know which companies have the most consistent track records of meeting or beating their EPS guidance, and which consistently miss it.

Exhibit 2: 10 Yr Stock Price Returns and 10 Yr EPS Growth Rates – 2005-2015

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Source: Capital IQ and SSR analysis

Exhibit 3: Average 1 Yr Stock Price Returns and 1 Yr EPS Growth Rates – 2005-2015


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Source: Capital IQ and SSR analysis

How Material Is the Impact of Missing Guidance on Utilities’ One-Year Stock Performance?

As discussed above, to assess the impact of utilities’ earnings performance relative to guidance, we ranked all of the regulated electric utilities in each year based upon the extent to which they missed or beat the March 1 consensus estimate (lowest rank = biggest miss, highest rank = biggest beat).

Comparing these rankings to the utilities’ stock price performance for the year, we found a meaningful difference between those in the top and bottom half of the distribution (Exhibit 4). The gap in stock price returns between utilities in the top and bottom half of the distribution averaged 5.5% over 2005-2015.

Exhibit 4: Returns of the Top and Bottom Half of Regulated Electric Utilities as Ranked by Size of Earnings Beat/Miss (March 1 Consensus Estimate vs. Actual Full Year Results) – 2005-2015

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Source: Capital IQ and SSR analysis

A materially larger gap in one-year stock price performance is evident between the extremes of the distribution. Thus the gap in returns between the five utilities with the largest earnings beats, relative to their March 1 consensus earnings estimates, and the five utilities with the largest earnings misses averaged 13.3% over 2005-2015.

Exhibit 5: Returns of the Top 5 and Bottom 5 of Regulated Electric Utilities as Ranked by Size of Earnings Beat/Miss – 2005-2015

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Source: Capital IQ and SSR analysis

Over time, however, the gap in returns between the top five and bottom five utilities, as well as between the top and the bottom half of the distribution, has declined significantly. Thus from 2005 through 2009, the gap in returns between the top five and bottom five utilities averaged 20.6%; from 2010-2012, this fell to 10.3%; and from 2013-2015 to only 4.1% (see the black line in Exhibit 5). Similarly, from 2005 through 2009, the gap in returns between the top and bottom halves of the distribution averaged 9.5%, whereas from 2010 through 2015 it has averaged only 2.2% (see the blue line in Exhibit 6 below).

As illustrated in Exhibit 6, the compression in the return differential between utilities that beat and miss their March 1 consensus earnings estimates coincides with a decline in the standard deviation of utilities’ earnings beats and misses. From 2005 through 2009, the standard deviation of utilities’ beats and misses averaged 15.5%; this fell to 12.4% over 2010-2012 and to only 5.6% over 2013-2015 (see the green line in Exhibit 6). Also falling over this period has been the correlation between utilities’ one-year stock price performance and the gap between their March 1 consensus earnings estimate and actual results for the year (plotted in red against the right hand axis of Exhibit 6). The correlation between earnings beats or misses and one-year stock price returns ranged between .45 and .52 over 2005-2007, but then began a gradual and irregular decline to only .17 in 2015. As the variability of earnings beats and misses fell over time, it appears that the importance to returns of utilities’ earnings performance versus March 1 consensus has declined as well.

Exhibit 6: Gap in Returns, Standard Deviation of Beat/Miss, and Correlation of Beat/Miss with Stock Price Returns – 2005-2015

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Source: Capital IQ and SSR analysis

We believe that the decline in the variability of utilities’ earnings beats and misses may be a reflection of reduced volatility in these companies’ earnings, as utilities have increasingly focused on regulated businesses or contracted generation. The reduced profitability of merchant generation following the drop in the price of natural gas, which has reduced the contribution of this very volatile segment to total earnings, may also be a factor. This drop in earnings volatility may have contributed in turn to increased accuracy of management guidance, reducing the size of earnings misses and thus their impact on returns for the average utility.

Which Utilities Consistently Meet or Miss Earnings Guidance?

The evidence presented above suggests that one-year returns on utility stocks are sensitive, particularly at the extremes, to a company’s success or failure in meeting their March 1 consensus EPS estimates for the year. It would helpful for investors to know, therefore, which companies have the best and worst track records of meeting or missing estimates. In Exhibit 7 we have ranked the regulated utilities by the frequency with which their full year results have met or exceeded March 1 consensus estimates. As can be seen there, WEC Energy has met or beat March 1 expectations in each of the last eleven years, and CMS Energy has done so in ten. Meeting or beating expectations in nine of the last eleven years were Edison International, IDACORP, OGE Energy, Public Service Enterprise Group and PNM Resources.

At the other end of the spectrum, Hawaiian Electric Industries has failed to meet March 1 consensus estimates in nine of the last eleven years, and Dominion Resources has failed to do so in eight.

Exhibit 7: Consistency – Number of Years Meet/Beat March 1 Consensus Earnings Estimate – 2005-2015 (11 years)

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Source: Capital IQ and SSR analysis

Given that the difference in one-year returns has historically been largest between the top five and bottom five utilities, ranked on the gap between their March 1 expectations and actual earnings for the year, we have also measured how frequently each utility appears in one or the other extreme of the distribution. As can be seen in Exhibit 8, Edison International has ranked among the five utilities with the largest beat on five occasions over the last eleven years, while CenterPoint Energy, Entergy, IDACORP, and OGE Energy have ranked among the top five on four occasions.

Exhibit 8: Number of Years in the Top 5 as Ranked by Size of Earnings Beat/Miss – 2005-2015 (11 years)

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Source: Capital IQ and SSR analysis

Conversely, as can be seen in Exhibit 9, Otter Tail has ranked among the five utilities with the largest earnings miss relative to March 1 consensus estimates on six occasions over the last eleven years, while Dominion Resources, Great Plains, and Hawaiian Electric Industries have done so on five occasions.

Exhibit 9: Number of Years in the Bottom 5 as Ranked by Size of Earnings Beat/Miss – 2005-2015 (11 years)

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Source: Capital IQ and SSR analysis

Finally, given the impact of extreme misses on returns, we also assessed the accuracy of companies’ guidance based on how widely they missed their mark. To do so, we first calculated for each year from 2005 through 2015 the average of the difference between March 1 consensus and actual earnings; second, we calculated the absolute values of these averages; and third, we calculated the standard deviation of the differences. As an indicator of the accuracy over time of companies’ initial guidance, we added to the absolute value of the average of the differences one standard deviation of the differences. If the earnings beats or misses formed a normal distribution, approximately two thirds of the observations would fall within a range of one standard deviation on either side of the mean; companies with high average gaps and high standard deviations around the average would thus be the ones offering the least accurate guidance.

In Exhibit 10, we have ranked the utilities into quintiles based upon their score on this index. As can be seen there, American Electric Power, CMS Energy, Exelon, NextEra Energy, SCANA, Southern Company and Xcel Energy were all among the most accurate providers of guidance. Avista, Edison International, Great Plains, Hawaiian Electric, OGE Energy, Otter Tail, and PNM Resources were the least accurate, although in the case of Edison International it appears to be solely due to large beats, rather than misses.

Exhibit 10: Accuracy – Quintile Ranking Based on Average of Miss/Beat plus 1 Std Deviation – 2005-2015 (1 = Most Accurate)

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Source: Capital IQ and SSR analysis

©2016, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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