Tesla Motors (NASDAQ: TSLA) has entered the electricity business in a big way by absorbing SolarCity and launching products like PowerWall and Solar Roof. That got me to thinking, is electricity a profitable product and will Elon Musk make money selling it?
The strange answer to those question is yes, because electricity can be considered a “value investment.” Warren Buffett’s Berkshire Hathaway (NYSE: BRK.H) is heavily invested in the electricity business; owning several electric companies including NV Energy in the United States and Northern Power Grid in the UK through Berkshire Hathaway Energy.
Berkshire also owns the battery maker Duracell. Tesla fans know that Musk is building one of the world’s largest battery production facilities at the Gigafactory in Nevada and planning several more.
If that was not enough; Berkshire Hathaway has invested $6 billion in five solar energy products including two of the biggest in the United States, its website claims. Tesla is heavily invested in the creation of battery storage and solar-electric generators and so is Berkshire Hathaway.
Is Solar Power a Value Investment?
The value investment argument for electricity is a pretty simple one; it’s a product that everybody needs ,and in most markets there’s only one supplier. That creates a moat and confirms to Buffett’s idea of the “toll bridge” a product people require and have to pay for.
Tesla potentially threatens that by offering customers a possibly cheap method of storing and producing their own electricity. Bloomberg writer Tom Randall claimed that Tesla’s Solar Roof; shingles that double as solar panels, is cheap enough to be competitive with conventional roofing materials.
It also points to a potential revenue stream for Tesla Energy of selling battery storage and solar panels to utilities. Tesla unveiled a 13 megawatt solar farm on the Hawaiian island of Kauai in March that relies on 272 Powerpack battery units to store electricity.
If it works as advertised the farm would reduce electricity prices on Kauai from 15.5¢ to 13.9¢ a kilowatt hour. So it is easy to see why Berkshire is so interested in solar it allows them to cut costs and increase profits.
Are Utilities still a Value Investment?
It sounds as if utilities might soon become more profitable because they might be able to dump costly energy sources like coal and nuclear for “free” energy from the sun. That might make them a long term value investment, but what about utilities now.?
To answer that question I crunched a few numbers for my local electric company Xcel Energy (NYSE: XEL) – the outfit to which I send $60 to $70 every month to keep my lights on and my computer working. Here’s what I found from the ycharts data:
- Xcel is making money. It reported a net income of $1.121 billion and a profit margin of 8.12% on March 31, 2017. The net income is up slightly from March 2016 when I was $1.074 billion.
- Xcel’s business is growing. Revenues were $10.38 billion in March 2016 and $11.28 billion in March 2017. Although they were down from $11.45 billion in March 2015.
- Xcel has very little float it reported cash and short-term investments of just $73.98 million on March 31, 2017; and a free cash flow of -$30.92 million on the same day.
- Xcel generates a lot of cash. It reported $2.968 billion in cash from operations. on March 31, 2017.There was also $319.64 million in cash from financing.
- Xcel has some book value it reported assets of $41.29 billion at the end of first quarter 2017, and an enterprise value of $39.31 billion on the same day.
- Xcel might be undervalued it had a market capitalization of $24.39 billion on June 1, 2017.
- You can make money from Xcel stock. Shareholders received a return on equity of 10.3% on March 31, 2017. They are also scheduled to take home a dividend of 36¢ on June 13, 2017. That dividend is growing as recently as December 22, 2016, it was 34¢.
- The dividend is fairly safe, Xcel has been paying a dividend every quarter since June 2012, ycharts data indicates.
All this is why utilities like Xcel are considered “widow’s and oprhan’s stocks” that is investments so safe people can rely on them for income. Yet the recent advances at Tesla call all that into question.
Just How Safe are Utility Stocks?
The danger to electric utilities is that they are in a technology intensive business – energy production. The events of the last few decades have proven that such businesses can be completely disrupted by new technology and safe streams of income quickly destroyed.
A case in point is newspapers, just 25 years ago owning a daily newspaper in the average American city was a license to print money. “The paper” was the main source of news and information for citizens and the only way most advertisers could reach a large audience.
Today newspapers are struggling to survive because the internet and Google have eaten their business. Gannett (NYSE: GCI) one of the nation’s largest newspapers reported a net income of $19.34 million on March 31, 2017. That was down from $152.44 million in March 2016. Not surprisingly, Gannett stock was trading at $7.76 a share on June 5, 2017.
Similar forces have destroyed the monopolies of other old media businesses such as network television stations. Their audience has been eroded by DVDs, videotapes, and streaming video.
Will electric utilities suffer a similar fate as companies like Tesla offer more flexible energy solutions? Only time will tell, but utility investors had better watch Tesla closely it might be a potential competitor or an ally that will make their stocks more valuable.
Either way large scale disruption of the electricity industry is quite probable in the coming decade. If the experience in newspapers is repeated in utilities, another reliable value investment might be about to become extinct.