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Feature Article

Challenges and Opportunities

By Roger S. Conrad on Dec. 7, 2014

Over the past 45 years, fat gains for the Dow Jones Utilities Average in October have usually led to flat results through year-end, a pattern that has played out thus far in 2015.

The utilities index has outperformed the S&P 500 Telecommunication Services Index, which has dropped 3 percent since the end of the third quarter. Even shares of water utilities have pulled back, though not necessarily to levels that would make them good buys.

The worst carnage has occurred in the energy sector, thanks to an almost $40 per barrel drop benchmark crude oil prices since mid-July and weakness in the prices of propane, butane and other natural gas liquids.

Exploration and production (E&P) stocks have taken the hardest hit. The NYSE ARCA Exchange Oil Index, which focuses on major integrated oil companies, has given up 11.2 percent of its value year to date; however, the Bloomberg North American Independent E&P Index, which comprises 77 smaller US and Canadian producers, has tumbled more than 30 percent since the end of the fourth quarter.

Although midstream operators have little direct exposure to energy prices, the Alerian MLP Infrastructure Index has dropped 7.3 percent since Sept. 30 and experienced the most volatility since 2010.

The renewable-energy segment has also been hit by the selloff, with SolarCity Corp (NSDQ: SCTY) losing about 10 percent of its value in the fourth quarter and SunPower Corp (NSDQ: SPWR) down almost 24 percent.

Even the formerly red-hot yieldco space has cooled off, despite a focus on long-term contracts that immunize their generation assets from fluctuations in oil prices. Both Abengoa Yield (NSDQ: ABY) and Pattern Energy Group (NSDQ: PEGI) have dropped at least 20 percent this quarter—a move that’s at odds with their solid third-quarter results.

Real Challenges

Unfortunately, North America’s energy complex faces real challenges, with dividend cuts most likely among oil and gas producers. And if oil prices fall to less than $60 a barrel for a prolonged period, bankruptcies will follow.

Midstream energy companies that provide pipeline and processing capacity under long-term contracts should hold up reasonably well, though some expansion projects could be jeopardized and contract defaults could become a problem in marginal basins.

Meanwhile, companies that manufacture solar panels and other equipment will have a much harder time competing against lower-priced fossil fuels.

The energy patch isn’t the only area under pressure. Surging capital spending needs, rising debt loads, intensifying competition and erratic regulation have weighed heavily on regional telecom players, especially those with heavy leverage.

Case in Point: NTELOS Holdings Corp (NSDQ: NTLS) earlier this month announced plans to wind down its operations in its eastern markets by November of next year, citing intense competition and rising promotional activity.

Other regional telecoms face the same pressure and continue to struggle to offset shrinking sales in legacy business lines with revenue growth from broadband services.

In these trying times, scale is essential. While the weak struggle for survival, the largest energy and telecom companies take advantage of their superior scale and balance sheets to lay the groundwork for future growth.

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