Credit analyst throws out Duke Energy as worst may not be over

By Ronda Fears

Nashville, Tenn., July 18 - Duke Energy's disclosures over round-trip power trades has caused Carol Levenson, director of research at Gimme Credit, to re-evaluate her previous endorsement of the credit. She now sees more downside, and said the company's plans for a convertible would be tough.

"We regret to admit recent disclosures and capital market events have prompted us to reevaluate our investment opinion on Duke Energy (A1/A+)," Levenson said in a report Thursday.

"Our previous endorsement of this credit was a highly qualified one, but it was an endorsement. We still consider Duke the best credit bet among the energy merchants. But the level of uncertainty surrounding the company has risen to an unacceptable level.

"We realize substantial damage to the bonds has already been done, but we don't feel we can say with confidence the worst is over. Although we have no way of knowing what these various investigations and inquiries could yet turn up, the company's credit quality is strong enough to withstand some fairly serious financial shocks. However, what has caused us to throw in the towel is Duke's evaporating financial flexibility."

She noted that Duke Energy had planned to tap the capital markets this year to refinance its Westcoast Energy acquisition.

"With the stock under this kind of pressure, it seems unlikely the 'equity-linked' portion of this refinancing could easily be accomplished," Levenson said.

In addition to the loss of financial flexibility within the capital markets from this ordeal, the analyst expressed specific concern about Duke Energy's lack of disclosure about the round-trip power trades.

"Duke has claimed from the first, even before the FERC investigation began, it didn't engage in any energy trades for the purpose of inflating volume or revenues or to manipulate prices," Levenson said.

In its response to FERC last month, Duke denied executing any 'round-trip' trades in the Western power markets during the period in question, finding only 13 power transactions out of 50,000 examined that could be considered simultaneous transactions, as defined by FERC, and only three natural gas transactions out of 30,000 examined.

Around the same time, Duke disclosed it had received an informal data request from the SEC regarding round-trip trading.

"Of course, Duke was not the only company being investigated nor the only subject of SEC inquiries. These were industry-wide investigations prompted by the infamous Enron market manipulation memoranda," Levenson noted.

"Naturally the fact there were questionable trades of any kind, no matter how insignificant, that could be interpreted as market manipulation was troubling."

Late last week, Duke disclosed its trading records had been subpoenaed by the Houston office of the U.S. Attorney regarding a grand jury investigation and also by the Commodities Futures Trading Commission.

On Tuesday, Duke released the preliminary results of the SEC inquiry, having identified 23 "paired transactions" that did appear to be done solely to increase volumes, although they had a negligible impact on revenues and none on earnings, according to the company.

"These trades were not reported earlier because the FERC inquiry only related to the Western markets," Levenson said.

She said she would like to know if these trades were discovered earlier and not reported because of the more limited geographic scope of the FERC inquiry, or during this phase of the investigation.

"The company has been neither forthcoming nor proactive in presenting these developments to the markets, and this has been part of its problem," Levenson said.

"Only in response to rumors and press reports has Duke come clean, including admitting a trader had been placed on administrative leave during the investigation."

While Duke Energy's need to access the capital markets to pay for the Westcoast acquisition is real, the analysts said that even more worrisome is some $8 billion in commercial paper, extendible notes and medium term notes outstanding at the end of March.

"Although Duke presumably could pay off maturing commercial paper by tapping its backup bank lines, we all know this is not an attractive long-term liquidity solution," Levenson said.

"We see additional downside here."

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