From the April 2010 issue of Research Magazine • Subscribe!

April 1, 2010

Utilities: Growth Drivers

With consolidation in the water industry, and diversification, hedging and cost cutting in the power industry, select companies in the utility industry are set to expand results.

James O. Lykins
J.J.B. Hilliard, W.L. Lyons, LLC
502-588-1799
jlykins@hilliard.com

We are currently recommending American Water Works (AWK), Aqua America (WTR), Artesian Resources (ARTNA), and California Water Service Group (CWT). Most of the water utilities under our coverage [just] reported fourth quarter results...although this quarter typically makes one of the smallest contributions to overall results due to seasonality.

Picking up where the third quarter left off, rainfall was above normal, occurred on consecutive days, and temperatures have been below average -- all negatives for usage.

However, we remain bullish on the group and believe one of the biggest growth drivers in 2010 will be consolidation. With the EPA estimating $335 billion needing to be spent over the next 20 years on water infrastructure and with municipalities continuing to struggle to meet budgets, we think an increasing number of them will seek to monetize assets.

We believe the prime beneficiaries on this front will be WTR and AWK. WTR typically makes about 25-30 acquisitions per year, and with the company making ~200 acquisitions over the past 14 years, this has long been part of the company's successful growth strategy.

In general, we view valuations among water utilities at present as attractive, and believe the current environment presents an opportunity to buy shares in the group before the seasonal earnings power of the summer begins to be priced into stock prices. Moreover, we note that many in the group will be facing easier comparisons in 2010, given record setting precipitation levels in the Northeast negatively impacting several in that portion of the country. This coupled with the anticipated benefit from pending rate case filings could drive significant EPS growth in 2010.

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Neil Kalton, CFA
Wells Fargo Securities
314-955-5239
Neil.Kalton@wachovia.com

We reiterate our Outperform rating on Public Service Enterprise Group and $33-34 valuation range.

Our '10 estimate EPS remains $3.15 and we are lowering our '11-'13 estimate EPS to $3.05, $2.90 & $3.05 from $3.10, $2.95 & $3.10. We view PEG as one of the more attractive Integrated Power Producer/Regulated names given a flat EPS profile, attractively located and diverse generation asset mix and strong regulated growth.

Having updated our model for '09 actuals and '10-12 CapEx and other guidance following PEG's analyst day, our '10 estimate EPS remains $3.15 and we are lowering our '11-'13 estimate EPS by $0.05 each to $3.05, $2.90 & $3.05. We view the flattish EPS profile favorably vs. peers such as Exelon (EXC/$44.97/MP) and PPL Corp. (PPL/$28.87/MP), which face declining EPS post-2010. We think PEG's regulated EPS growth will nearly offset lower Power EPS.

PEG plans regulated CapEx of $1.9B, $1.7B & $1.6B during '10-'12 vs. $0.9B in '09, resulting in annual rate base growth of 14%. Nearly 70% of the planned investment is covered by riders that allow for immediate cash recovery, including $2.2B of FERC-regulated transmission. PEG should not require external equity to fund the program given the rider mechanisms and strong PSEG Power cash flows. We estimate PSE&G's EPS contribution will grow from $0.63 in '09 to $1.20 by 2013.

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Jonathan Arnold
Deutsche Bank
212- 250-3182
jonathan.arnold@db.com

We are increasing our 2011 and 2012 estimates to $4.05 and $3.20 from $4.00 and $3.15, respectively, largely reflecting the impact of Exelon's updated hedging disclosure. During Q4-'09, EXC hedged unsold generation at prices above our forecasts.

We continue to see additional upside potential to 2011 and 2012 since our Midwest and Mid-Atlantic power price forecasts for unsold generation remain below the current forward curve.

We are maintaining our 2010 estimate of $3.75.

EXC reported Q4-'09 operating EPS of $0.92 versus our $0.90 estimate and consensus of $0.86, with the beat largely attributable to greater-than-anticipated cost reductions. EXC delivered $100M of cost savings over plan.

We value EXC at $47, attributing $12 to the utilities and $35 to Generation.

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