Utilities Can Reap Big Rewards From Sustainable Practices

Renew Grid, Wednesday May 30, 2012 - 00:00:00

Good sustainability policies and practices, including energy efficiency and demand side management, could be worth billions of dollars to utility investors, according to a report from Target Rock Advisors LLC.

"Earlier this year, we demonstrated that as a group, the stocks of utilities that scored highly in Target Rock's sustainability rankings outperformed companies with lower sustainability performance over the 10 years ended Dec. 31, 2011," says Richard Rudden, CEO of Target Rock. "Now, we have been able to place an estimate around the potential value that improved sustainability practices might bring to utility equities."

Comparative analysis of the 10-year total returns for the 49 utilities included in Target Rock's 2012 sustainability rankings and indexes, along with several "what-if" scenario tests, suggest that the value of sustainability could be worth between $20 billion and $25 billion.

This estimate reflects the incremental market value realized by Target Rock's high sustainability index plus the opportunity costs associated with being less sustainable for the medium and low sustainability indexes.

The $20 billion to $25 billion range represents 8% to 10% of the total starting market capitalization of the utilities covered by the Target Rock indexes and an additional 1% of relatively low-risk compound annual return over 10 years. With the three major utility indexes (S&P Utilities, Dow Jones Utility Average and Philadelphia Utility Index) posting an average compound annual growth rate of 3.6% over that period, another 1% is quite material, and the numbers could be larger going forward, according to Target Rock.

"This analysis indicates that utilities' sustainability efforts contributed positively to long-term total returns, even if relatively modestly," says Kyle Rudden, partner and co-founder of Target Rock. "It is important to keep in mind that this analysis includes a period of time, particularly the earlier years, when only a handful of the most progressive utilities had sustainability plans in place. The impact of sustainability practices on shareholder returns could be more substantial over the next decade now that more utilities are taking the issues seriously."

In addition, while the $20 billion to $25 billion estimate is a relevant indicator of shareholder value, these figures understate the true economic value of sustainability, because market capitalization metrics do not capture socioeconomic benefits created by utilities but accrued to others and society as a whole. These benefits include reductions in pollution and water use all along the consumption and carbon chain, as well as contributions to local economic health and development.

It is impossible to say just how much causality is implicit in the relationship between strong sustainability practices and higher market returns - and there are certainly other factors in play - but Target Rock Advisors believes there is enough of a connection to use these relative performance baselines as a reasonable foundation for a "what-if" analysis in estimating the value of overall sustainability in the U.S. utility sector.

The what-if analysis estimates what the total return indexes would have been if each sustainability group scored - and, thus performed in the market - like the next-highest group over the 10-year period.

Specifically, it was assumed that the low- and medium-sustainability companies upped sustainability profiles and performed in line with the actual performance of the medium and low groups, respectively. The high sustainability group's what-if scenario considers the outcome if it had not been as sustainable, and instead resembled the medium group.

Not controlling for market capitalization, the high sustainability group produced excess market capitalization of about $10 billion for the period, while the medium and low groups theoretically left $11 billion and $3 billion on the table. Under the size-controlled analysis, the comparable numbers for the high, medium and low groups were $12 billion, $8 billion and $4 billion respectively.

"While the precision of this estimate is necessarily limited by the universal complexity of sustainability assessment, it does provide an informed effort to place direction and boundaries around the potential industry-wide shareholder value of sustainability as measured by market capitalization metrics," says Kyle Rudden.

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