Customers May Hate Pepco, But Investors Find a Lot To Love

by Susan J. Aluise | July 15, 2011 4:19 am

Given the choice between a popular company and a profitable company, most investors would choose the latter. But what about a company that has the dubious distinction of being the most hated company in America? Can hefty dividends and a rosy outlook offset customer revulsion?

As with most things in the financial world, the answer is “it depends.” Case in point: Pepco Holdings (NYSE: POM[1]), a Washington, D.C.-based utility that supplies electricity to 1.8 million customers in the mid-Atlantic region. Business Insight last week labeled POM the most hated company in America, based on data from the recent American Customer Satisfaction Index (ACSI) survey. On a 100-point scale, Pepco managed a customer satisfaction rate of only 54 – lower than the most despised banks and cable TV services on the list.

A customer satisfaction score of 54 out of 100 is bad for any company – particularly a utility, where the sector average is 74. Only one of the other 29 utilities named in the survey scored below a 70 – PG&E (NYSE: PGE[2]), which came in with a 67. What’s even worse, POM’s score reflects a 16-point drop – a nearly 23% loss of customer satisfaction – since this time last year.

Low satisfaction is usually an issue of rates and reliability.  According to the ACSI report, Pepco customers experienced 70% more power outages over the past year than did households in any other metropolitan area – and those outages averaged twice as long.

POM may be weathering the wrath of customers and utility regulators, but it’s feeling a lot of love from shareholders. For starters, the company paid out $240 million in dividends last year alone. At 5.50%, Pepco’s dividend yield is among the highest in the utility industry – a sector with a reputation for high-flying dividends.

At $19.66, POM is trading more than 21% above its 52-week low of $16.17 this time last year – and 26 cents above its one-year target price. Its first-quarter 2011 earnings rose to $62 million (28 cents/share) on revenue of $2.5 billion. That’s an increase of more than 77% over the $36 million (16 cents a share) the company reported in the first quarter of last year.

POM has a market cap of $4.42 billion with a price-to-earnings growth (PEG) ratio of 2.46 – high enough to suggest that the stock is overvalued. Pepco has $18 million in cash and total debt of $4.70 billion. Last week, Pepco applied for a 5.3% rate increase that, if approved, would add another $42 million a year to the utility’s coffers.

Bottom Line: While the fundamentals are strong and POM investors have had a good run this year, future returns may depend on Pepco’s ability to make friends and influence people – particularly regulators. D.C. regulators last week promised to levy fines of $10,000 per incident if the utility fails to cut outages by 9% a year – and reduce the length of those outages by 3.4% a year. The new performance standards start in 2013.

Maryland lawmakers passed a bill earlier this year that would fine electric utilities $25,000 per day for each violation of reliability standards. POM plans to boost its performance by cutting trees that fall on lines and upgrading its infrastructure to boost reliability.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.

Endnotes:
  1. POM: http://studio-5.financialcontent.com/investplace/quote?Symbol=POM
  2. PGE: http://studio-5.financialcontent.com/investplace/quote?Symbol=PGE

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