Executive Voices: An Op Ed Column

Back to Basics
At Progress Energy, we never forgot who we are or what we do best

By William Cavanaugh III

Earning investor trust and confidence has been challenging for many companies over the past year or so, especially in the energy sector. The dramatic collapse of Enron in December 2001 and the fight for survival by other once-high-flying energy companies in 2002 have raised serious questions about this key business sector.

Yet, not all energy companies are created equal, nor are they operated in lockstep with one another. Some, including Progress Energy, demonstrated a commitment to openness and integrity long before it was in vogue. A recent example was the comprehensive audit of 500 U.S. companies by Standard and Poor’s. Progress Energy was one of only three companies — and the only energy company — to receive the highest rating for providing investors with the most detailed and complete information on finances, operations and corporate governance.

Still, the turbulence in the energy sector since 2001 can’t be ignored. It has produced four important lessons that clarify what is required to be a successful energy company today and to create lasting shareholder value.

Set realistic growth expectations. Contrary to what Wall Street led many people to believe, energy companies are not fast-growing enterprises. Total energy consumption in the United States between 1990 and 2002 grew an average annual rate of 1.56 percent. Individual companies can certainly grow at a much greater rate than the overall demand for electricity by taking share from weaker companies or expanding into new markets. We have done that at Progress Energy. Our revenue and net income have grown an average of 14 percent and 9 percent annually since 1994. But still, we know that the fundamentals are such that an energy company in our sector typically grows net income at about 3 to 4 percent.

Maximizing operational efficiency and acquiring or developing additional capacity will produce revenue growth that exceeds consumption rates, of course, but not on a long-term basis. Therefore, if an energy company forecasts double-digit growth rates over multiple years without adding new assets or expanding into new markets, either the forecast is inaccurate or the company is not an energy company, at least not entirely.

Know who you are. The recent bull market tested the discipline of many companies within the sector. Wall Street was rewarding new energy companies with stratospheric price-to-earnings multiples. Enron’s PE multiple once eclipsed 50, while the multiples of traditional energy companies languished in the low teens or worse. In the rush to tap into the stock market’s momentum, companies forgot who they were. As a result, they pursued flavor-of-the-month business lines that failed to support their long-range plans, hired people lacking in-depth knowledge of the industry and made imprudent, costly investments — errors now reflected in their discounted stock prices. Conversely, companies that remained committed to their long-term strategies have generally enjoyed stronger stock performance.

Don’t bet the company on a single strategy. As energy companies ventured into unfamiliar territory, some mortgaged their core utility businesses. Effective corporate stewardship, this is not. For Progress Energy, the integrated utility company — both producing and distributing energy — has proven to be the most effective business model in today’s energy sector. Much the way a diversified investment portfolio minimizes risk, integrated companies are able to balance the volatility of producing power in unregulated markets with the stability of distributing power in regulated markets. Companies lacking this balance are at a strategic disadvantage today.

 Enron traded far more energy than it produced and, therefore, was vulnerable to sharp price fluctuations in spot markets that ultimately led to spectacular losses. Similarly, many companies that only produced energy fell victim to the bottom falling out of the wholesale market. We have made some investments outside our core competencies that did not produce as we had hoped, particularly in the technology sector. But we did not bet the company’s future on the success or failure of these ventures, and we learned some valuable lessons along the way.

When it comes to integrity, practice what you preach. Not every company that talks a good game on corporate conduct actually lives up to it. Enron espoused the values of communication, respect, integrity and excellence, though its actions fell well short of the mark. The financial malfeasance by some companies within and outside the energy sector is impossible in an environment in which integrity truly counts. Companies whose management demonstrate and reward values like honesty and collaboration often have happy employees — and happy shareholders — to show for it. The two are not mutually exclusive. In a trusting environment, employees are generally more productive, which enhances a company’s performance. In turn, better-performing companies generally have better-performing stocks, especially if management has proven that it can be trusted.

Despite the travails of many companies and the very real challenges the industry faces, the energy sector has a bright long-term outlook. Technology and economic expansion will continue to drive an increase in consumption. Globally, two-thirds of the world’s population is without electricity. The best bets to outperform the market are companies that deliver cost-effective energy solutions to their customers, remain true to their identities and demonstrate character in their operations. After several years where the popular focus in the energy sector was everywhere but energy, many people now want to get back to the basics. Some of us never left.

William Cavanaugh III of Raleigh is chairman and chief executive office of Progress Energy.

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