What are the key financial ratios for utility companies?
The current ratio measures a company's capacity to meet its current obligations, typically due in one year. This metric evaluates a company's overall financial health by dividing its current assets by current liabilities. A current ratio of 1.5 to 3 is often considered good.
The current ratio measures a company's capacity to meet its current obligations, typically due in one year. This metric evaluates a company's overall financial health by dividing its current assets by current liabilities. A current ratio of 1.5 to 3 is often considered good.
The four key ratios for analysts and investors to use when analyzing the energy sector include—debt-to-EBITDA, interest coverage ratio, debt-to-capital, and debt-to-equity. Debt can increase shareholder returns, as the cost of debt is lower than the cost of equity.
Typical capital structures for regulated utilities in the U.S. are in the range of 40% debt to 60% equity and 60% debt to 40% equity.
The most common way of valuing US utilities stocks uses price-to-earnings (P/E) ratios: a company's market value compared to next year's projected profit.
The average net profit margin in the sector was nearly 10% in the first quarter of 2022 and for the trailing 12 months (TTM) was almost 11%. The average gross margin was 66.04% in the first quarter of 2022, and the average earnings before interest, taxes, depreciation, and amortization (EBITDA) margin was 34.29%.
Utility debt is unique in that utilities have the ability to carry highly levered capital structures while still maintaining a high credit rating.
Capital-intensive industries, such as utilities, have relatively higher D/E ratios. Therefore, D/E ratios should be considered in comparison to similar companies within the same industry. Generally, ratios of 0.5 and below are considered excellent, while ratios above 2.0 are viewed more unfavorably.
Financial ratios are grouped into the following categories: Liquidity ratios. Leverage ratios. Efficiency ratios.
Ratio | Formula |
---|---|
Inventory Turnover Ratio | COGS/average inventory |
Days sales in inventory (non-ratio metric related to inventory turnover ratio) | Days sales in inventory = (average inventory/COGS) X 365 |
Asset Turnover Ratio | Asset turnover ratio = net sales/average total assets |
What is the asset turnover ratio for utilities sector?
In the retail sector, an asset turnover ratio of 2.5 or more could be considered good, while a company in the utilities sector is more likely to aim for an asset turnover ratio that's between 0.25 and 0.5.
Allocate a reasonable percentage, such as 5–10%, of your monthly income toward utilities. Consider the size of your home. Larger homes typically require higher utility budgets due to increased heating, cooling, and energy needs.
Utilities require a significant amount of expensive infrastructure and consequently carry large amounts of debt on their balance sheets. These debt loads make utilities hypersensitive to changes in the market interest rate.
The income approach assumes that the value of property is established by determining the present value of the income stream which it can generate. Traditionally, an income approach to utility valuation was based on the rate of return on rate base and then discounted by the market cost of capital.
Key performance indicators for utilities' transmission and distribution functions include: Grid reliability - Length and frequency of power outages as a percentage of total operating time. Lower is more reliable. Power quality - Frequency and duration of voltage sags, spikes, and harmonic distortion incidents.
Here's the basic idea behind this century-year-old utility business model: utilities make profit by investing in the infrastructure, like pipes and wires, that provide energy services to customers.
Generally, a gross profit margin of between 50–70% is good and anything above that is very good. A gross profit margin below 50% is usually not desirable – though lower margins can still be sustainable for businesses with fewer production and operating costs.
Marginal utility is the added satisfaction a consumer gets from having one more unit of a good or service. The concept of marginal utility is used by economists to determine how much of an item consumers are willing to purchase. The law of diminishing marginal utility is often used to justify progressive taxes.
Overall, though, a 5% margin is low, a 10% margin is average, and a 20% margin is good or high. So try to target a net profit margin between 15% and 20% in your business. How can you increase profit margin?
Interest Rates and Debt Levels
Of course, an interest-rate hike affects all businesses this way, but it's an especially important factor for utility companies because of their typically high debt levels. Major utility firms have major capital expenditures and high debt-to-market cap levels.
What are the 4 leverage ratios?
Common leverage ratios include the debt-equity ratio, equity multiplier, degree of financial leverage, and consumer leverage ratio. Banks have regulatory oversight on the level of leverage they can hold.
Utilities offer competitive returns and lower risk
The result is a durable earnings and dividend stream that has the lowest beta, a measure of volatility, of any other sector in the market. Additionally, during periods of elevated inflation and rising interest rates, utility stocks have generally outperformed bonds.
Generally, a good debt-to-equity ratio is anything lower than 1.0. A ratio of 2.0 or higher is usually considered risky. If a debt-to-equity ratio is negative, it means that the company has more liabilities than assets—this company would be considered extremely risky.
By calculating the ratio between your income and your debts, you get your “debt ratio.” This is something the banks are very interested in. A debt ratio below 30% is excellent. Above 40% is critical. Lenders could deny you a loan.
This ratio is a measure of financial risk or financial leverage. In the previous example, the company with the 50% debt to equity ratio is less risky than the firm with the 1.25 debt to equity ratio since debt is a riskier form of financing than equity4.
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