Should You Follow Mr. Buffett Into the Utilities Sector?

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Following and investing with Warren Buffett has been a wealth-maximizing move for millions of investors.  Since taking control of Berkshire Hathaway (NYSE: BRK-B) in 1965, he has generated a 19.7% compounded annual growth in book value per share, impressive to say the least.  However, with Berkshire’s assets topping $400 billion, Buffett and company have had to move into slower growth, regulated sectors like railroads and utilities.  The company’s latest purchase is a strong bet on Vegas, agreeing to acquire NV Energy (NYSE: NVE) for $23.75 per share in cash or roughly $5.6 billion.  So, should small investors follow this move?

What’s the value?

NV Energy is Nevada’s dominant electricity provider, offering power to customers in the southern and northern portions of the state through its Nevada Power and Sierra Pacific Power units, respectively.  The company has been a beneficiary of the growth of Las Vegas’ population and corresponding power needs, providing service to roughly 850,000 customers in the Las Vegas metro area as of December 2012.  With the area’s population growth waning, though, NV Energy has been trying to increase its efficiency through the construction of a transmission network that will connect its northern and southern territories.

In its latest fiscal year, NV Energy reported a marginal gain in revenues, up 1.2%, but it enjoyed a strong 28.5% increase in operating income.  The chief cause of the pickup in profit was an approved rate increase for 2012, as well as a small increase in its customer base.  In addition, NV Energy raised its gross margin by internally generating more of its power production, 69% of total system requirements, which allowed it to take advantage of lower natural gas prices.

Joining the empire

Looking ahead, NV Energy needed to continue improving its financial profile in order to fund its large capital expenditures and meet Nevada’s escalating renewables mandate, currently set at 18% of a utility’s production.  Partnering with Berkshire makes perfect sense, as Berkshire’s MidAmerican energy unit is one of the nation’s largest wind and solar power generators.  As for Berkshire, the purchase expands the geographic reach of its MidAmerican unit at a reasonable price, paying approximately 7 times operating income.

In its latest fiscal year, Berkshire generated strong financial results, with earnings before taxes up 45%, as it enjoyed broad-based gains across its diverse insurance and operating businesses.  However, the MidAmerican unit was the lone profit decliner, due to volatile wholesale power prices and higher operating costs.  Despite the lack of profit growth, though, the unit still generated almost $2 billion in segment operating income and leveraged the parent company’s financial strength to invest more than $3 billion in new assets during the period.

A global utility play

While Berkshire is always a good investment choice, due to its unparalleled management philosophy, investors might want to consider to direct play on growing global power demand.  Brookfield Infrastructure Partners (NYSE: BIP) owns a variety of assets, including transportation terminals and natural resources, but almost half of its assets are in the utilities sector.  It also has a preference for international markets, owning major electricity service providers in the U.K., New Zealand, and Chile.

In its latest fiscal year, Brookfield Infrastructure Partners’ utility segment enjoyed solid financial growth, with increases in revenues and adjusted operating income of 20.2% and 12.0%, respectively, versus the prior year.  The unit’s sales growth benefited from rising customer counts and usage trends, as well as an expansion into new markets, including the Columbia regulated utility sector.  Like other industry participants, the company is also investing heavily in renewables, with construction plans for transmission lines in the U.S. that will efficiently connect Texas wind farms with high population metro areas.

The bottom line

The utilities sector isn’t a high growth industry, but its revenues generally rise in line with population growth, which can be enhanced by rate increases.  The sector’s consistent returns across business cycles are leading major investors like Berkshire to allocate a larger portion of their assets to the sector, with the MidAmerican unit accounting for over a third of Berkshire’s total capital expenditures in 2012.  Rising economic growth around the world will require increasing amounts of electricity to power that activity, making the sector an area where investors must have a position.  With the developing world set to continue growing faster than the developed world over the long run, Brookfield Infrastructure Partners is the one to watch.

More on Buffett

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Robert Hanley owns shares of Berkshire Hathaway. The Motley Fool recommends Brookfield Infrastructure Partners. The Motley Fool owns shares of Brookfield Infrastructure Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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