April 18 - Is TXU Risking a Backlash?

Over the past year and half, Texas Utilities (TXU) has seen its stock fly off the map as new management, a massive restructuring, a surge in earnings and some healthy financial engineering have sparked a quadrupling of the company’s stock price. All is well in Dallas, where TXU officials and patient investors have been enriched beyond their wildest expectations. This company has been the poster child of a group that has had some run. But while the TXU story still seems pretty attractive, it seems to me like there is an issue on the horizon that bears watching.

I say this because last Friday, TXU filed a request with the Texas Public Utilities Commission to significantly boost its electricity rates on account of high natural gas prices. This is permitted under the state’s retail competition law, which, if memory serves, works as follows. Under deregulation, utilities must sell power at a regulated rate until 2007 or until 40 percent of its customers change to different suppliers. The initial rates, set in 2001, carved about ten percent off the top of those rates that existed prior to deregulation. Subsequent to that action, TXU was able to pass through two price increases in 2002 when the price of Natural Gas rose and hence their fuel costs rose. These rates increase, for all intents and purposes, wiped out most of the price cuts that came from deregulation.

Well, TXU is now back in Austin asking for a ten percent rate hike, and Wall Street loves the move, arguing that it will be a significant earnings driver for the company. As such, some think this company can do about $6.50 in earnings this year and perhaps $8 next year. That 2006 number is probably triple where it was eighteen months ago. With the stock trading at 84, TXU is a relative bargain if these estimates come to fruition. But here is the catch. How long can the company keep getting away with these rate increases? How long will the PUC stand idly by and let TXU sock it to the ratepayers of Texas. After all, the stock has quadrupled and don’t think for a second this fact is lost on regulators. They know how rich people have gotten off this story and at some point it seems likely that they will force shareholders to absorb some of the pain that TXU wants to inflict on its customers. And if the law and the courts deny the PUC any discretion on this front, then how long will it take for some populists in the state legislature to take a look at this issue and the state of deregulation?

My point here is TXU is taking a risk that it will incur some sort of regulatory or legislative backlash. I know they operate in Texas where making money off energy is a way of life, but this is power and not gas. The last time I checked, Texas was still part of the Confederacy and, as such, economic populism still carries the day in the area of regulatory rates. I am not going to sit here and say TXU doesn’t have every right to push for these increases, but buyer be warned, regulators and lawmakers have no obligation to oblige. At some point, critics of TXU may say enough is enough and ratepayers are not going to incur additional costs for the benefit of TXU stockholders. It may be nice that Wall Streets analysts think this company will earn eight bucks next year, but what if the Texas legislature thinks five is enough in 2006 or 2007 or 2008? That would probably be unlikely in a low rate environment, but with rates surging, who is to say that regulatory changes are not coming? With that in mind, keep an eye on TXU’s dividend, because if it doesn’t start rising to keep pace with all these EPS surges, it says the company may not feel too comfortable that this rate climate has legs.