Duke convertible buyers turn out on unchanged dividend, plans to cut debt

By Ronda Fears

Nashville, Jan. 7 - Duke Energy Corp. shares staged a comeback Wednesday after the company said it would leave its common dividend intact. The convertibles surged along with the stock, propelled by buyers who traders said emerged in droves.

The stock rebound was largely due to short covering, one dealer said, as many investors were betting that the prediction by Merrill Lynch equity analyst Steven Fleishman for a roughly 30% dividend cut would come to pass and, thus, further pressure the stock.

"When the company in fact stood pat on the dividend, then the shorts got squeezed and they had to start running for cover," the trader said.

The trader added that a fairly large contingency of the short selling was from some of the hedge funds that play the Duke convertibles; thus, they became big buyers in the converts.

For the most part, however, dealers said there was mostly real buy-and-hold interest in the Duke convertibles.

"There was a drove of buyers" of Duke convertibles, one dealer said, noting that many debt holders were encouraged by the company's commitment to reduce debt by another $3.5 to $4 billion this year without dipping into its cash reserves of some $1 billion.

Duke shares, which were indicated to open around $1.25 higher, indeed climbed for most of the session after losing 29 cents on Tuesday in reaction to Fleishman's prediction.

The stock ended the day up $1.17, or 5.84%, to $21.20.

Late afternoon, with the stock at $21.30, Duke's 1.75% convertible due 2023 was at 104 bid, 104.625 offered, a gain of about 1 point.

Duke's two mandatory convertible issues that mature in 2004 rebounded sharply as well, and both also saw heavy volume. The 8.25% issue rose 0.7 point, or 5.16%, to 14.26, while the 8% issue added 0.7 point, or 5%, to 14.7.

The mandatory convertibles actually saved the day, or the dividend, in the view of CreditSights analysts Dot Matthews and Andy DeVries.

In a telephone interview, the analysts said they did not have an investment recommendation on any of the Duke convertibles but saw the conversion of the $1.6 billion of mandatories in 2004 as the equivalent of a huge cash injection that would bolster equity.

The analysts said Duke shares appear to be overvalued at current prices.

On Duke's straight debt, however, the analysts cut their recommendation from overweight to marketweight on recent tightening but also due to execution risk and the possibility of a one-notch downgrade to the ratings.

They bumped their recommendation on Duke Capital debt, however, from marketweight to overweight despite the possible downgrade, because they do not see it falling below investment grade. Matthews noted that in the company's conference call Duke chief executive Paul Anderson reiterated that the parent would continue to support the unit.

Anderson said Duke would maintain its annual dividend of $1.10 per share and focus on more modest growth. Toward that end, the company is in the process of exiting the European and Australian areas, although remaining in Latin America, and making further cutbacks in energy trading.

Due to the divestitures, Duke is recording a $3.3 billion pretax charge in fourth quarter 2003, and that is expected to result in a net loss per share of $1.45 to $1.50 for 2003.

The company reports earnings Jan. 29.

Anderson, who just took the helm at Duke in November, said that to demonstrate a commitment to the proposition, senior management's incentive plan will not kick in if the company's earnings per share fall below the dividend objective of $1.10 a share.

"Target earnings for the incentive plan have been set at $1.20 per share, which reflects a realistic base from which we can reestablish earnings momentum," he said.

Anderson said that in addition to supporting the dividend, cash flow in 2004 will fund $2.2 billion in capital expenditures and, when coupled with asset sales, will allow for debt reduction of another $3.5 to $4 billion.

In mid-December, Duke announced settlements with the Federal Energy Regulatory Commission related to its role in the California electricity crisis from January 2000 through June 2002. The company agreed to pay up to $4.59 million to California and electricity consumers in the western United States.

The company, however, remains a party to FERC's ongoing refund case involving all participants in the California market from Oct. 2, 2000 through June 20, 2001. For that, the company has put about $90 million in reserve.

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