Duke Energy, KeySpan, Dominion among credit analyst's power picks

By Ronda Fears

Nashville, Tenn., May 28 - While even the safest power and energy names are risky, Carol Levenson, director of research at Gimme Credit, said there are a few exceptions.

Among the energy trading names, her pick is Duke Energy, which has two mandatory convertibles in play.

Among the utility names without much in the way of energy trading, she likes Wisconsin Energy (A2/A-), SCANA (A3/A), Southern Co. (A3/A), Keyspan (A3/A), Exelon (Baa2/A-), Energy East (Baa2/BBB+), and Dominion Resources (Baa1/BBB+).

KeySpan and Dominion both have mandatory convertibles in play.

"At the time of Enron's swift demise, we advised bond investors to steer clear of other companies primarily engaged in competitive energy trading and power sales," Levenson said in a report Tuesday

"The only exception we've been willing to make is Duke Energy (A1/A+), because we hope the company will benefit competitively from a flight to quality and might not have too many Enron-like skeletons buried in its financial closet."

As companies such as CMS, Reliant Energy, Mirant, Dynegy, Aquila, Williams and El Paso continue to suffer from constrained financial flexibility, accounting scrutiny, regulatory and legal difficulties and in some cases management upheaval, she said her fears seem justified.

All of those names except Dynegy and Aquila have convertibles outstanding.

"Understandably, our litany of 'avoid' recommendations has prompted our clients to ask us whether there are any utility/energy companies we feel good about," Levenson said.

"We have compiled some information buttressing our dismal outlook for credit quality in this sector, but we have also come up with a few relatively safe names."

All the recommendation are based on the same underlying reason - they still get most of their cash flow and income from regulated activities, the analyst said.

"We've said it before and we'll say it again: it is impossible to conceive of an industry that has made more blunders venturing outside its core business than the utility industry, all in pursuit of earnings growth," Levenson said.

In the 1980s when utilities first began to diversify, there were unfortunate investments in cable television, savings and loans, mining, insurance, real estate development and citrus groves, she noted.

"You would think unregulated ventures involving energy and power would fare somewhat better, but obviously they have not," the analyst said.

"Finding a company in this sector that's likely to be upgraded is like searching for the proverbial needle in a haystack."

Of roughly 70 utility and energy names that Gimme Credit follows, not one is currently under review for an upgrade and only two carry a positive outlook from one of the two major rating agencies, she said.

On the other hand, 19 carry a negative outlook and another 18 are under review for downgrade.

"Another problem with even the more conservative names is how swiftly these companies can increase their business risk," Levenson said.

"Even if energy trading volumes turn out to be enhanced, sales growth in these unregulated segments has been exponential, while huge spending programs have increased unregulated assets. Furthermore, with unregulated earnings growth targeted at multiples of regulated earnings growth, simple math decrees riskier activities will comprise a larger proportion of earnings and cash flow in the future."

The earnings and cash flow volatility in unregulated businesses makes the simpler worries of utilities in yesteryear - rate cases, intervenors, and nuclear plant cost overruns - far more appealing, she said.

"We note that even among the names we consider relatively safe, nearly all have promised to reduce debt through asset sales," Levenson said.

"But the logical buyers of many of these assets, especially if they are (power) generating assets, are the firms who are capital-constrained today. Hence a caution: nearly every name we will list is vulnerable to a modest downgrade if they don't meet their debt reduction targets in the next year."

A good rule of thumb, she said, is to look for a utility that discusses "heating degree days" or the economy in its service territory in its earnings releases or filings, instead of VAR or spark spreads.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.