Salomon: Duke Energy best idea in the "yawn index" of power names

By Ronda Fears

Nashville, Tenn., May 22 - The Salomon Smith Barney power & merchant energy conference last week drew a large crowd, said Salomon convertible analyst Stuart Novick, but he added it's tough to know if the rooms were filled with value buyers looking for ideas, short sellers looking for ideas or current holders wanting to get a better idea of exactly what they're holding.

Thus, Novick came up with a "yawn index" that identifies the most boring - or safest - names in the power and merchant energy names.

There are about 25 power and merchant energy names in the convertible universe and Novick said in a report Wednesday that Duke Energy was his best idea in the group, although KeySpan and Cinergy ranked well in an analysis of the group for less exposure to unregulated trading activities.

"Investor confidence in the sector has been damaged by one issue after another," Novick said in the report.

"The most recent revelations to hit these companies involve 'round tripping' on the energy trading side of the businesses. Those problems come on the heels of a litany of other issues that continue to plague the sector and in the process have severely eroded investors' comfort for the group."

Indeed, in the post-Enron world, energy providers have been slammed by accusations of "gaming" power costs and supplies into California during last year's power crisis, he noted, and also have been fingered for hiding off balance sheet transactions or obligations and concealing debt accelerating triggers.

"That said, boring might be better from a buyer's standpoint. Noting the aforementioned concerns, it seems that old fashioned, dull electric utility operations may be most appealing to credit concerned convertible investors given the proverbial 'island in the storm' status of those predictable cash flows," Novick said.

"While some utilities highlighted their integrated business models during the conference, few of them went out of their way to really stress the regulated portion of their business, in our opinion. From our credit-oriented point of view, we think that that approach, as compared to discussions of corporate earnings expectations, would have done more to calm investors."

To come up with the "yawn index," Novick looked for those more weighted toward regulated operations as they would be more predictable, hence more desirable.

Other factors considered were equity risk ratings, year-to-date price performance, percent of non-regulated EBIT, leverage and fixed charge coverage ratios. Debt to capital ratios also included off-balance sheet obligations, he noted.

"Our rankings didn't yield much in the way of surprises. It did, however, reaffirm some of our hunches," Novick said.

Thirteen names made it to the index.

In the top three positions, in order, were Duke, Keyspan and Cinergy - three firms with a large percentage of cash flows coming from regulated utility operations. Dominion Resources and TXU Corp. tied for the next position. At the sixth post was Reliant Energy.

At the bottom of the list, in order, were Mirant and Calpine - a pair of companies whose stocks have suffered given their significant exposure to the volatile merchant power and energy marketing businesses.

Others between the top half of the list and the bottom two, in order, were Aquila Inc., El Paso Corp., PPL Corp., Sempra Energy and Williams Cos. Inc.

Duke Energy 8.25% mandatory due 2004

Ratings: A/A3

Convertible Price: 23.73

Common Price: $34.25

Current Yield: 8.69%

Common Yield: 3.2%

Conversion Premium: 8.0%

Fair Value: 22.84

Spread: 125 bp

Breakeven: 1.3 years

Strike: $47.56/$38.98

Conv Ratio: 0.527/0.641

Delta: 76.4%

Volatility: 32.0%

Upside: 62%

Downside: 77%

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