El Paso plans doesn't ease credit worries, credit analyst sees little upside

By Ronda Fears

Nashville, Tenn., May 30 - El Paso's new, improved restructuring plan has significant execution risk and with performance suffering because of it, Carol Levenson, director of research at Gimme Credit, sees little upside in the credit.

"If history repeats itself, expect Mirant and Dynegy to announce new, improved balance sheet enhancement programs this week. Yesterday El Paso Corp. (Baa2/ BBB+) followed Williams with Version 2.0 of its December restructuring plan," Levenson said in a report Thursday.

"You may recall all four of these companies announced their credit strengthening plans within a week of each other last December, and all successfully issued equity soon afterward. Some were downgraded anyway, some succeeded in fending off downgrades and some merely postponed the inevitable."

But El Paso not only avoided being downgraded, it also maintained stable outlooks from both major rating agencies throughout the subsequent turmoil in the power industry, the analyst noted.

And, so far at least, the company doesn't appear to be under investigation for any trading or

accounting mischief, she added.

Nevertheless, the stock market punished El Paso severely Wednesday, after having reacted quite mildly to Williams's plans the day before.

"The difference, we believe, is in El Paso's dramatically reduced earnings guidance and its plans to severely cut back its trading operations,'

El Paso promised to issue $1.5 billion in equity, sell natural gas gathering assets to the convenient El Paso Energy Partners for $800 million and cut annual costs by $300 million.

"So far so good. But when the company finally got around to illustrating the effect of these moves on its balance sheet (the last slide in the presentation, by the way), it seems also to have included asset sales remaining from Version 1.0 of the balance sheet enhancement plan," Levenson said.

"Thus the pro forma balance sheet shows a much more dramatic improvement than yesterday's announcement alone would produce. While we find this a trifle disingenuous, there's no denying, if all goes as planned, with the execution of both programs El Paso's leverage would drop by about 10 percentage points by the end of this year. "

Nevertheless, Levenson said that by her calculations, El Paso's leverage will still be at an uncomfortably high 60%.

"Don't even try to compare this with the company's figures, which treat certain items in a much more generous fashion," she said, noting that El Paso is no longer talking about free cash flow helping it to reach its debt reduction goals, "and it's a good thing."

The company's cash flow in the first quarter was disappointing, she said, with free cash flow negative by a good $700 million, a drop of nearly $1 billion from the prior year.

"Moreover, using the company's lowered earnings estimates, some 20% below consensus estimates, we project free cash flow to be little better than breakeven this year," Levenson said.

"Note this is estimated without trying to model unpredictable swings in working capital items or the cash effect of risk management activities, and it does include a rather miraculous cash booster of $500 million from the company's estimate of deferred taxes."

Ironically, the analyst said, the best news bond investors heard was El Paso's plan to cut way back on its energy trading activities and the capital committed to them, with a goal of lowering the contribution from noncash earnings to 5% by next year.

"Management claimed the stock market was undervaluing these operations, yet surely the news that El Paso was exiting this go-go business accounted at least in part for yesterday's stock price drop of nearly 25%," Levenson said.

"This casts some doubt on the promised equity issuance. If the equity plans fall through, the promised diminution in business risk is the only substantive credit quality positive to emerge from yesterday's brouhaha. We see little upside in this name."

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