Drivers of Utility Profitability

As Europe's utilities increasingly expand beyond incumbent markets, a broad comparison of financial performance becomes key to understanding where and how certain utilities outperform their peers on basic financial measurements such as profitability. Historic performance, market focus, value chain focus and even sheer size all must be tested as contributing factors to utility profitability.



Report Highlights
Counter-intuitively, an accumulation of strong cash flows over time does not explain profitability levels in 2006. There are as many top performing utilities which saw cash flow fall from 2002 to 2006, as those which saw their level of cash flow increase over that period. On average, the top ten most profitable utilities in 2006 derived 62% of their revenue from markets that can be described as traditional or incumbent markets, substantially less than for the most poorly-performing utilities. Gearing levels amongst utilities do not explain why some utilities are more profitable. Endesa, for instance, has the highest level of debt-to-equity amongst the utilities examined, yet it was the seventh most profitable utility in 2006.


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DATAMONITOR VIEW 1
CATALYST 1
SUMMARY 1
ANALYSIS 2
This brief reviews the financial performance of 30 leading utilities 2
This brief reviews the financial performance of 30 leading utilities 2
60% of utilities saw profitability fall in 2006 3
Six of the 10 most profitable utilities have seen their results fall from their 2005 peak 3
RWE and EDF have substantially improved their position from among the least profitable major utilities in Europe 4
PPC and Centrica were the only utilities to make a net loss in 2006 5
Only three utilities have consistently outperformed over the past five years 6
Profitability in 2006 was not a function of performance in prior years 7
Profitability in 2006 was not driven by stable revenue growth over time 7
The most profitable utilities in 2006 have not produced stable profit growth over time 8
The most profitable utilities are not necessarily those with the highest growth in operating cash flow 9
Profitability is not a function of size 10
Economies of scale from the operation of fixed assets do not account for differences in profitability 10
Employee costs are not a driver of utility profitability over time 11
Europe's most profitable utilities derive income from different parts of the value chain 12
Top-performing utilities show a real diversity in terms of where along the value chain operating income is generated 12
Business units that are big revenue earners tend to contribute less to operating income 13
Accumulation and use of debt does not itself explain the profitability of European utilities 14
Debt leverage does not correlate to profitability 14
From 2002-06, utilities that have outperformed on profit growth do not show a consistent approach to debt leverage 15
Effective use of debt capital over time does not itself explain profit growth 16
Spain, Russia, Denmark and the Czech Republic consistently account for the most profitable utilities 17
In 2006, Switzerland and the UK encompassed some of the most and least profitable utilities 17
Top-performing utilities tend to be less focused on traditional (incumbent) markets 18
Poorly performing utilities tend to be more focused on traditional (incumbent) markets 19
APPENDIX 20
Definitions 20
Datamonitor Consultancy 20
Ask the analyst 20
Disclaimer 20

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Figure 1: Leading European utilities, in order of profitability in 2006 2
Figure 2: Top decile of utilities by profitability (2006), with five-year results 3
Figure 3: Middle decile of utilities by profitability (2006), with five-year results 4
Figure 4: Bottom decile of utilities by profitability (2006), with five-year results 5
Figure 5: The 10 most profitable utilities, 2002-06 6
Figure 6: Revenue growth, 2002-06 7
Figure 7: Growth in net income, 2002-06 8
Figure 8: Growth in operating cash flow, 2002-06 9
Figure 9: Fixed assets and profitability, 2006 10
Figure 10: Revenue per employee and growth rates, 2002-06 11
Figure 11: Operating income by business unit segment, 2006 12
Figure 12: Business unit segmentation of revenue and operating income, 2006 13
Figure 13: Levels of debt leverage, 2006 14
Figure 14: Average growth in net income and debt leverage, 2002-06 15
Figure 15: Average growth in long-term debt and revenue, 2002-06 16
Figure 16: Home markets of the most and least profitable utilities, 2006 17
Figure 17: Proportion of utility revenue from incumbent and new markets 18
Figure 18: Proportion of utility revenue from incumbent and new markets 19

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