Steven M. Brown, editor in chief
The worst–financially speaking–appears to be over for the energy and utilities sector. The industry has turned a corner, and, while all is not entirely well, the most recent numbers available to EL&P show marked improvements in income and cash flow were achieved in 2003.
A year ago when EL&P published its September 2003 industry report on the health of the energy and utilities sector, all indications pointed to continued but slow financial recovery. That forecast was based on 2002’s financial data. Now, with the benefit of 2003’s numbers, that prognosis can be confirmed. As a result of much belt-tightening and a continued back-to-basics approach, the industry seems to be back on solid financial ground.
What becomes immediately evident upon examining the 2003 numbers is an industry that has done a good job of paying down its debt. It is also an industry that saw improved income in 2003 but was loath to spend it on capital projects or pay it out in the form of increased dividends.
the good news
EL&P’s 2003 financial data was provided by the C Three Group of Atlanta (www.cthree.net). Data came directly from annual and quarterly reports filed at the Security and Exchange Commission by each company.
Several key market indicators showed substantial improvement in 2003. Aggregate energy and utility industry statistics are summarized in table 1. Click here to view all tables
Among the most notable statistics:
“- industry-wide free cash flow (operating cash flow less capital expenditures) was positive for the first time since 1998. Showing an approximate $20 billion improvement between 2002 and 2003, industry-wide free cash flow went from being $8.3 billion in the red to $11.7 billion in the black.
“- total industry net income also rebounded significantly, from a negative $5 billion in 2002 to a positive $11.3 billion in 2003.
“- debt-to-equity ratios also showed good improvement between 2002 and 2003. Long-term debt fell by $15 billion, and shareholder equity increased by nearly $10 billion. This amounted to about a 4 percent decline in debt and a corresponding 4 percent increase in equity.
The industry also saw increases in total revenue, total operating income, comprehensive income and operating cash flow.
“What we saw in 2003, and what we’re seeing in 2004, is fairly strong recovery as an industry,” said Jean Reaves Rollins, C Three Group founder. “Certainly, there are companies out there that are still struggling from the events of 2000 and 2001, but for the most part, the industry has recovered.”
While the $16 billion turnaround in net income is at first brush impressive, Rollins noted that the figure reflects a lot of write-offs companies were forced into taking, writing down the value of assets, etc.
“The $16 billion swing (in net income) reflects industry recovery, however it still hasn’t gotten back to the levels we saw back in the ’90s, 2000 or 2001,” Rollins said.
Market capitalization–one of the more straightforward criteria by which a company’s value may be judged–also showed improvement in 2003. Market cap rebounded from a five-year low of $293.7 billion in 2002 to nearly $375 billion in 2003. This is still a far cry from $514 million figure reported in 2000 and is still more than $20 billion below the 2001 level, but it does indicate that Wall Street is beginning to view the industry in a more favorable light.
Table 2 show the top 50 energy companies based on 2003 market capitalization, along with their 2002 rankings on that same criteria. Southern Company, Exelon, Dominion Resources and Duke Energy each retained their 2002 top-four rankings in 2003.
the other side of the coin
Other 2003 statistics show that while the industry witnessed improved income and did an admirable job of paying down debt, it did little in the way of investing in capital projects. Employment numbers were also down, and dividend payouts declined. Energy and utility companies in 2003 had a good deal of money flowing in, but little going out for anything other than debt retirement.
“- capital expenditures dropped from $70 billion in 2002 to $53.7 billion in 2003. Industry-wide, capital expenditures were at a five-year low in 2003.
“- concurrent with the pronounced dip in spending on capital projects was continued job loss in the industry. Number of employees was at a four-year low in 2003, down nearly 70,000 from 2002.
“- common dividend payments, after increasing fairly steadily from 1998 to 2002, were at a six-year low in 2003 and were down about $1.3 billion from 2002.
The dip in capital expenditures, said Rollins, reflects not only a drop in expenditures on generation construction, but also significant belt-tightening in other areas–non-regulated businesses in particular. She also noted that the increase in free cash flow is directly related to the decrease in capital spending.
“Free cash flow is basically operating cash flow less capital expenditures,” she said. “It’s a reflection that companies have really cut the heck out of capital budgets.”
So, taken as a whole, the energy and utilities sector in 2003, did not invest its free cash in capital projects. Nor did companies buy back their own stock. (Rollins noted that “common stock repurchased” was at its lowest level in 10 to 15 years.) Nor did they increase dividends. What the industry did–and did quite well–was pay down its debt. The industry’s long-term-debt-to-equity ratio fell from 1.66 in 2002 to 1.53 in 2003.
“There’s been a lot of pressure from Wall Street for these companies to get rid of some of their debt,” Rollins said. “You had a huge jump in debt retirement from 2002 to 2003. A lot of companies are using their money to buy down their debt.”
Given what seems to be a disconnect between money coming into energy and utilities companies and money going back out into capital projects, EL&P chose “total revenue” and “capital expenditures” as criteria to rank energy and utilities companies this year.
The top spots in total revenue (table 3) have held fairly firm from 2002 to 2003. Duke is No. 1 in total revenues for a third straight year. The company’s total revenue increased by $6.6 billion from 2002 to 2003. Williams’ jumped to the No. 2 spot in the 2003 total revenue rankings, primarily, Rollins noted, as a result of Issue 02-3 of the Financial Accounting Standards Board’s Emerging Issues Task Force (EITF Issue 02-3), which required that revenues and costs of sale from non-derivative contracts and certain physically settled derivative contracts be reported on a gross basis.
Most of the rest of the 2002 top 10 remained in the 2003 top 10, with the exception of PG&E, which fell from No. 9 in 2002, just out of the top 10 to No. 11 in 2003. El Paso Energy, No. 4 in 2002, didn’t report numbers by the time C Three Group collected data for its analysis.
Table 4 ranks energy and utilities companies according to their 2003 capital expenditures. Dominion Resources increased its capital expenditures by $610 million from 2002 to 2003 and rose from the No. 5 spot to the No. 1 spot. FPL Group rose from the fourth spot in 2002 to No. 2 in 2003 despite cutting capital expenditures by more than $500 million. Duke Energy fell from the No. 1 spot in 2002 to the No. 3 spot in 2003 after cutting capital expenditures by nearly $2.5 billion. Calpine experienced a similar drop in the rankings (from No. 2 to No. 6) as a result of a $2 billion cut in capital expenditures.
While most companies decreased their capital spending–in some cases, quite significantly–Progress Energy ($650.8 million) Dominion Resources ($610 million), and Centerpoint Energy ($364.5 million) are companies that stand out for dramatically increasing their capital expenditures.
In 2003, energy and utilities companies continued a steady financial recuperation. Companies generally sat on cash and paid down debt, improving the sector’s appeal on Wall Street. Signs point to continued recovery, and that will likely be borne out in the 2004 numbers, which EL&P will report on a year from now.
Two trends to watch: Will the after-effects of the Aug. 14, 2003, blackout show up in increased capital spending when the 2004 numbers come out, and will the industry begin to see pressure to reverse the downward trend in average dividend payout?
At the present, there is little indication that either trend will reverse significantly. More belt-tightening may be the most likely scenario for a continued trend in the immediate future.