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Constellation Energy (NYSE:CEG) and Reliant’s (NYSE:RRI) liquidity scares sparked fear that other electrical utilities could end up in a similar position. But industry sources working in the sector told dealReporter most utility companies continue to have access to credit lines.
”I do not understand why people make a case for the precarious health of utilities,” said Dorothea Matthews, a senior utilities analyst at Creditsights. ”People are clamoring to give money to utility companies, but at increased cost.”
Long-term debt is still available for power companies in the current market, agreed John Anderson, head of power and project finance in the bond and corporate finance group at John Hancock Financial Services. He said he has seen regulated utilities raise 30-year debt at just an 8% coupon in the past few weeks, which he thought is an encouraging sign.
Driving investor concern about utilities is the fact that the companies need steady access to capital in order to operate and expand their operations to meet expected future demand. If the companies lose access, they may be put in a difficult position. Constellation, for instance, ran into trouble when bad energy trading bets led investors to fear the company may have to post additional collateral and lose access to its credit lines. The company announced it was selling itself to MidAmerican Energy in September.
Industry sources said other utilities are unlikely to abruptly lose access to credit since following the demise of Enron in 2001 companies have worked to strengthen their balance sheets by securing long-term credit facilities. But the sources said the higher cost of debt may negatively impact utilities in the coming years.
Independent power producers (IPPs) may face the most challenges because they do not have guaranteed cash flows, an industry banker said. IPPs generally do not have access to commercial paper markets and instead rely on longer-term borrowing. Stocks in the sector have fallen 50% or more over the past few months on liquidity concerns and general market unease.
At the same time, the industry sources noted IPPs’ low valuations also make them potentially better investment opportunities. Many utilities are trading well below the fundamental value of their assets, said Jone-Lin Wang, a managing director in Cambridge Energy Research Associates’ global power group.
The utilities investor said Mirant (NYSE:MIR), Calpine (NYSE:CPN), Dynegy (NYSE:DYN) and AES (NYSE:AES) are attractively priced and could interest acquirers. On Monday Exelon (NYSE:EXC) took advantage of IPP NRG Energy’s (NYSE:NRG) depreciated stock price to launch an unsolicited offer for the company.
Driving long-term concern with utilities is the fact that the industry will need billions in new capital to fund mandatory infrastructure programs. As a regulated industry, utilities are required to expand to meet customer need. To fund that expansion, utilities have turned to external financing, since they have not been able to generate enough internal cash to cover the costs.
While utilities still have access to credit markets, the credit crisis means they have had to pay more for the debt. Matthews said Southern California Edison, a subsidiary of Edison International (NYSE:EIX), recently issued five-year paper at 340 bps over a benchmark US Treasury, compared to 155bps over 10-year paper in August.
One positive factor for the sector is that historically the companies have fared better in downturns than other industries because consumers typically do not reduce their electricity use, Wang said. However, a combination of the higher debt costs and average equity returns of 10.5% to 11% mean firms’ margins will be squeezed until utilities are able to raise rates, she said.
Both Wang and Matthews said utilities may try to delay capital expenditures in the hope that credit markets will return to normal by next year. But Wang said at some point utilities will be forced to invest in new infrastructure, no matter credit conditions, in order to relieve historically tight capacity.
Jeffrey Sterba, CEO of PNM Resources (NYSE:PNM), a New Mexico-based regulated utility, agreed firms cannot put off projects for too long. ”This year [as an industry] we will spend over 80bn on new capital expenditures,” Sterba said. ”That will probably go up, not down. So there’s a significant demand for capital formation within our industry, because of transmission districts and expansion, much less environment and climate change.”
Regulated utility firms like Duke Energy (NYSE:DUK) and MidAmerican Energy are better positioned to operate in a higher-cost environment, industry sources said. Duke spooked investors in early October when it announced it had drawn down USD 1bn from its master credit agreement. But a second industry banker said Duke continues to have access to commercial paper and bond markets and he said Duke’s disclosure needlessly created fear that the company might not be able to access capital.
Additional reporting by Bryce Covert and Heather West.
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