Asset management is not an easy business.
Finding the right opportunities, maximizing alpha, choosing the right broker and maintaining market compliance are only a few of the things a buysider must navigate to be successful. Take for example Reaves Asset Management, which has been in the business of investing in the equities of essential infrastructure sectors of the economy for over four decades.
Jay Rhame, Reaves Asset Management
Founder William H. Reaves built on his experience and knowledge as head of electric utility research at Kidder Peabody to create the framework for the firm’s research-driven investment philosophy. In 1978, Reaves began managing its first institutional account focused exclusively on the utility and energy infrastructure sectors.
Today, the Reaves team remains committed to the principles of its founder as an employee-owned, research-based investment management company still specializing in key infrastructure-related industries such as utilities, energy, and communications. Client assets are managed by a team of experienced professionals with an objective to generate a growing stream of dividend income and capital appreciation.
The firm’s Long Term Value institutional strategy has also quietly outperformed the S&P 500 Index since it launched almost 42 years ago. Jay Rhame, Chief Executive Officer of Reaves, recently spoke with Traders Magazine to discuss their investment strategy and the opportunities his firm sees going forward in these trading sectors.
Traders Magazine: Tell us about your investment strategy and why it has worked well for so long.
Jay Rhame: We’ve always believed that a team of specialists performing fundamental research can create an investment advantage over time. We study and invest in utility, communications, and energy companies. Our team has spent most of their careers following these industries, and so we’re true experts in these fields. The results of this approach speak for itself –we’ve outperformed the S&P 500 Index in our Long Term Value institutional strategy over the nearly 42-year period dating back to January 1978. We think the opportunity to continue to do well is better than it has been in a while as well. So much of the money flow into these sectors is driven by ETFs and investors positioning defensively for a risk-off environment. This means that the stocks are often highly correlated which can create a lot of relative value opportunities for managers like us.
TM: Can you give us an example?
Rhame: Utilities are generally slow growth companies but within the sector there’s a lot of dispersion. In its latest earnings conference call, NextEra Energy reiterated that it expected to grow earnings six to eight percent per year through 2022. Northwest Natural, on the other hand, struggles to find any growth, and if consensus 2020 estimates are right, the company will earn less in 2020 than it did in 2010. Management’s forward expectations are for growth of just three to five percent. However, Northwest Natural trades at a higher valuation than NextEra. Classic fundamental analysis would tell you a situation like this is impossible, but we see valuation discrepancies like this all the time in the sector.
TM: In which situations does your longevity help you the most?
Rhame: The best value we provide to our clients is by missing the investment disasters. Pacific Gas and Electric is the latest example. We owned the stock in 2017 when the first of the big California fires hit but quickly realized that the company faced a potential bankruptcy if the 2018 fire season was bad. We were out of the stock by the end of 2017 when it was trading in the $50’s. The company filed for bankruptcy in January 2019 and today trades at less than $7. We couldn’t have predicted the disastrous 2018 fire season, of course, but we understood the regulatory environment and the risks it posed to the company.
We exited positions in Enron and WorldCom long before they imploded in the early 2000s. We’ve always taken the approach that we need to understand the risks we take on anytime we buy a stock. As long as we understand the risks and appreciate the potential outcomes, the upside takes care of itself.
TM: What are the opportunities you see going forward?
Rhame: Utility and communications companies are in much better positions than they have been in a long time. For utilities, it starts with renewable energy. Companies have a chance to remake the entire power grid, earn a regulated return on the amount of invested capital, and have significant earnings growth. It’s all possible because the cost of renewable energy has fallen dramatically. Right now, the cheapest form of power available is from a wind farm in the central part of the United States. Many utilities can shut down existing coal and nuclear power plants, replace them with brand new wind and solar, and save customers money. Battery storage costs have fallen as well, and many companies are looking at combining batteries, wind, and solar to solve many of the reliability issues.
The programs are very popular. People love the cleaner air, the projects create jobs, and customer bills go down. Renewable costs should continue to decline making the economic incentive to change the power grid even stronger in the future. Well-run utilities should have the ability to grow earnings consistently in the mid to high single digit range for the next decade. As the market gains confidence in the consistency of that earnings growth, we think it could result in higher valuations.
On the communications side, broadband cable, wireless towers, and data centers are well positioned. Cable companies should be able to continue to gain market share in high margin residential broadband and business service segments. Network and product quality improvements are helping to reduce costs resulting in improving cash flow dynamics.
Growth in the wireless tower sector is set to improve once the Sprint/T-Mobile merger is resolved. Whether the merger goes through or not, competition in wireless should intensify, forcing the carriers to differentiate with better network quality. There is a significant amount of new spectrum is waiting to be deployed that will drive strong growth for the tower companies over the next several years. Data centers will benefit from what we believe will be a long-term secular trend of businesses outsourcing IT and using shared telecom infrastructure.
