Why Investing in Utility Companies is a Good Idea...

Mar 2, 2016

In this issue:
» Corporate taxes in India remain high
» RBI's move to improve core capital of banks
» ...and more!
Radhika Pandit, Managing Editor of ValuePro

Warren Buffett's annual shareholders meeting is the most anticipated event in the investing world. And for the die-hard value investor, the letter that Buffett writes to shareholders is something to really look forward to. For this is no ordinary letter. Indeed, besides the usual update on Berkshire's business and investments, Warren Buffett also doles out nuggets of investment wisdom. And these are always interesting.

The 2015 annual letter is no exception. Buffett touched upon a variety of topics - his four big investments, the importance of productivity gains especially in a country like the US, and his views on BNSF and BHE.

Today, I will focus on those two businesses.

Burlington Northern Santa Fe and Berkshire Hathaway Energy are utility companies. In that sense, they are different from your typical 'Buffett-would-buy' company.

How so?

Buffett has always favoured companies with strong competitive advantages little or no debt on the books, and robust dividend payouts.

Utility companies are a different lot altogether. As Buffett himself states in his 2015 letter:

  • We have two major operations, BNSF and BHE, that share important characteristics distinguishing them from our other businesses. A key characteristic of both companies is their huge investment in very long-lived, regulated assets, with these partially funded by large amounts of long-term debt that is not guaranteed by Berkshire.

So they operate in a regulated environment, and these companies do have a fair bit of debt on their books. What does Buffett like about them then?

Buffett explains in his latest shareholder letter:

  • Each company has earning power that even under terrible economic conditions would far exceed its interest requirements. Last year, for example, in a disappointing year for railroads, BNSF's interest coverage was more than 8:1.
  • Both enjoy a factor common to all utilities: recession-resistant earnings, which result from these companies offering an essential service on an exclusive basis.

Society will always need huge investments in both transportation and energy. And it is in the self-interest of governments to treat capital providers in a manner that will ensure the continued flow of funds to essential projects.

We agree. While managing ValuePro, not only do I scout for the typical Buffett-style company with strong brands, but I keep an eye on utilities as well.

In fact, my team and I have already recommended two utility companies in the ValuePro portfolios. Besides providing an essential service, these companies have very little or no debt on their books. This is quite commendable given that both these companies have capital intensive businesses. And near-term hiccups aside, we believe that they have the potential to add to shareholder wealth in the longer run.

Do you think that utility companies are good value creators in the long term? Let us know your comments or share your views in the Equitymaster Club.

--- Advertisement ---
Profit From Junior Blue Chips...

We have released our latest Special Report on the best of the best small caps - Junior Blue Chips!

Yes, we believe Junior Blue Chips possess the high growth potential of small caps along with the stability of blue chips.

That is an amazing combination every investor would want in his portfolio.

And the best part is you can get this report for FREE!

Just click here to know how...

3:03 Chart of the day

If India has to realize its dream of 'Make in India' then it needs to improve the ease of doing business in the country. One of the factors impacting business is the incidence of corporate taxes. The corporate taxes in India, at over 33%, are still higher than most of the other countries. However, this is only one side of the coin.

The average tax rate, in fact, works out to 24.67% due to various exemptions, incentives, and deductions availed by companies. The companies operating in the infrastructure, mining, IT and drugs and pharmaceuticals sectors are subject to lower effective tax rates on account of numerous deductions enjoyed by them.

To ensure that the corporate tax burden remains equitable, the government has laid down the framework of reducing corporate tax rates from 30% to 25% along with rationalization or phasing out of corporate tax exemptions. In the Union Budget 2016-17, the government is in active consideration of phasing out of tax incentives and exemptions. Principal among them are, restricting the accelerated depreciation for IT companies to 40% from FY18 and limiting the deductions allowed for Research & Development to 150% from FY18 and to 100% from FY21 onwards. Since the additional revenues from phase-out of exemptions would be available gradually, the government would be rationalizing the corporate tax rates in a staggered manner.

In the Union Budget 2016-17, the government has allowed new companies formed after 1st March 2016 to be taxed at 25% provided they do not claim any tax benefits. Additionally, small companies with turnover of less than Rs 50 million would be taxed at a lower rate of 29% from FY17 onwards. These measures are expected to bring down the corporate tax rates in an even manner.

Indian Cos Continue to Face High Tax Burden


Moving from corporate tax rates, another factor that can impede economic recovery is the bad loans clogging the banking system. Public sector banks (PSBs) have been battling the demon of bad loans for quite some time now.

As if this was not enough, sluggish credit offtake along with jump in provisioning after the recent asset quality review by RBI have severely constricted their earnings with some of them posting losses in the December 2015 quarter. This has greatly impacted the capital adequacy of a number of PSBs at a time when they also need to fulfil Basel III requirements.

The capital infusion of Rs 250 billion provided in the Union Budget 2016-17 remains grossly inadequate. To address this issue, the Reserve Bank of India has relaxed some regulations in the computation of Tier I capital or core capital of banks.

As per the revised norms, additional reserves arising out of revaluation of properties would be considered as Tier I capital after a 55% discount. This is likely to help unlock the value of large amount of real estate holdings of PSBs and shore up their capital strength. Additionally, RBI has also permitted part of foreign currency translation reserves and deferred taxes to be included in Tier I capital. This move by RBI is likely to ease some of the capital constraints being faced by PSBs presently.


Indian markets traded firm today on the back of sustained buying momentum in the index heavyweights. At the time of writing, BSE Sensex was trading higher by around 448 points. Barring FMCG, all the sectoral indices were finding favour, with stocks from banking and IT notching the most gains. Stocks from both the smallcap and midcap spaces also did well. The BSE Midcap and BSE Smallcap were trading higher by 2% each.

4:55 Today's investment mantra

"Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).

Today's Premium Edition.

Tobacco Companies' Rendezvous with Budget 2016

Judging the impact of the budget on the fortunes of cigarette companies.
Read On...Get Access

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "Why Investing in Utility Companies is a Good Idea...". Click here!

Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.

An independent research initiative, Equitymaster is committed to providing honest and unbiased views, opinions and recommendations on various investment opportunities across asset classes.

There are no outstanding litigations against the Company, it subsidiaries and its Directors.

For the terms and conditions for research reports click here.

Details of Associates are available here.

  1. 'subject company' is a company on which a buy/sell/hold view or target price is given/changed in this Research Report
  2. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any financial interest in the subject company.
  3. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have actual/beneficial ownership of one percent or more securities of the subject company at the end of the month immediately preceding the date of publication of the research report.
  4. Neither Equitymaster, it's Associates, Research Analyst or his/her relative have any other material conflict of interest at the time of publication of the research report.
  1. Neither Equitymaster nor it's Associates have received any compensation from the subject company in the past twelve months.
  2. Neither Equitymaster nor it's Associates have managed or co-managed public offering of securities for the subject company in the past twelve months.
  3. Neither Equitymaster nor it's Associates have received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  4. Neither Equitymaster nor it's Associates have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months.
  5. Neither Equitymaster nor it's Associates have received any compensation or other benefits from the subject company or third party in connection with the research report.
  1. The Research Analyst has not served as an officer, director or employee of the subject company.
  2. Equitymaster or the Research Analyst has not been engaged in market making activity for the subject company.
Definitions of Terms Used:
  1. Buy recommendation: This means that the investor could consider buying the concerned stock at current market price keeping in mind the tenure and objective of the recommendation service.
  2. Hold recommendation: This means that the investor could consider holding on to the shares of the company until further update and not buy more of the stock at current market price.
  3. Buy at lower price: This means that the investor should wait for some correction in the market price so that the stock can be bought at more attractive valuations keeping in mind the tenure and the objective of the service.
  4. Sell recommendation: This means that the investor could consider selling the stock at current market price keeping in mind the objective of the recommendation service.
If you have any feedback or query or wish to report a matter, please do not hesitate to write to us.