Top 91 IOUs: The incredible shrinking universe

Michael T. Burr

Managing Editor

When EL&P`s Top 100 IOUs financial report shrank to include only 99 companies last year, the industry passed a critical milestone. As the report`s author, Robert Smock, wrote, “Financial analyst Ed Tirello`s prediction that only 50 IOUs would survive seemed outrageous when he made it about 10 years ago, but now it`s beginning to look pretty good.”

This year, the ranks thin further. The universe of major U.S. utility holding companies shrinks to 91 for this year`s report-and that number includes the AES Corp., whose merger with CILCORP is still pending. With numerous other mergers and acquisitions in the works, the universe will likely shrink further before the end of the year.

One of the most interesting phenomena emerging in the industry`s consolidation is the expanding presence of traditionally non-utility companies. The number one company in terms of revenues, for two years running, is Enron. While Enron is an unusual case, its presence is symptomatic of a larger trend. CalEnergy`s 1998 acquisition of MidAmerican Energy is a prime example, as are the pending AES/CILCORP and Dynegy/Illinova mergers (See related story, “Dynegy-Illinova deal signals re-integration,” page 1).

This report provides some interesting analysis of the trend. For instance, investors value diversification. The market/book ratios of utility stocks rise as their ratios of retail to total revenues fall (see figure). In other words, the more retail-dependent the company, the less desirable its stock on Wall Street-generally speaking. Market-book ratios average nearly 1.8 for companies that derive 50 percent or less of their revenues from retail electricity sales, compared to just over 1.4 for their 80 percent retail- revenues counterparts.

Granted, none of these ratios are in the double-digit realms frequented by Internet stocks and other speculative industries. Nevertheless, the correlation is compelling.

In addition to Enron, some other out-of-market examples continue the trend. Montana Power Co., with a market/book ratio of 3.7, derives less than one-third of its revenues from retail electricity sales. Most of the company`s growth has been through its telecommunications subsidiary, Touch America. Similarly, NiSource Inc. relies on retail sales for just over 30 percent of its revenues, and nets a healthy 2.5 market/book ratio. The company`s reliance on retail will contract further if NiSource prevails in its hostile bid for Columbia Energy (See related story, “NiSource pursuit continues,” page 11).

The leading company on the list in terms of market/book spread is AES, with a 6.8 ratio. But since AES is not a retail utility in the United States (yet), its U.S. revenues are all from wholesale. Dividing CILCORP`s $559 million retail sales by AES and CILCORP`s combined total revenues yields an 11.3 percent electric/retail figure. Only time will tell, however, how AES` acquisitions of such companies as CILCORP and New Energy Ventures might affect its stock performance.

Other examples buck the trend. IPALCO Enterprises, a Wall Street darling with a 3.7 market/book premium, nets nearly 85 percent of its revenues from electricity sales. Its performance is enhanced by low operating costs and rising electricity sales. Another example, PECO Energy, is 64 percent electric revenue-dependent, but fetches a 3.8 market/book markup. Its strength last year came largely from a $5 billion stranded cost-recovery deal. Promising prospects for its AmerGen nuclear and Exelon energy services affiliates didn`t hurt, either.

Despite a few exceptions, the correlation between stock value and non-electric revenues is clear. How diversification affects profitability and growth, however, is less certain. Comparing holding companies` electric/ total revenue ratios to their net income growth yields no clear correlation-yet. But as retail competition proliferates and different companies pursue their respective growth strategies, the winning combination might begin emerging.

Waiting for the FERC

Much of the data for the Top IOUs report are drawn from utilities` FERC Form 1 filings. Because the Federal Energy Regulatory Commission is still working to perfect its electronic filing system, however, some Form 1 data figures were unavailable at press time. Electric revenue figures mentioned above for Montana Power, NiSource and IPALCO, for instance, were gleaned from the company`s 1997 sales.

Navigant Consulting Inc. of Springfield, Ill., provided the data for this year`s Top IOUs report. The Navigant Knowledge System (NKS) provides, among other things, financial, operating and demographic information for IOUs. Fortunately, NKS uses many sources in addition to FERC for its data. Many of the figures are drawn from utilities` 10K and 10Q filings.

Despite delays in getting all the numbers from FERC, the available data provide plenty of fodder for analysis. Except for the Form 1 data, the figures presented here cover the 12 months ending March 31, 1999. This accounts for the 1999 year dates shown on most of the tables. Our purpose in using results from this period is to provide the most up-to-date information possible.

Particularly interesting to watch are shifting revenue rankings of various utilities, and the reasons for these changes. Perhaps the most dramatic descent is demonstrated by Dominion Resources, which goes from its previous ninth place to 22nd. The change is related to two major factors. First, Dominion sold its interests in U.K. utility East Midlands. Second, a rate case settlement with Virginia Power reduced earnings by more than $200 million. Finally the company realized a 1997 windfall profits tax from East Midlands during 1998.

Also worth noting are the rising figures of Reliant Energy and Sempra Energy. These are new names to the Top IOUs table, but the predecessor companies are, of course, familiar. Reliant is Houston Industries` new name, and Sempra was formed from the merger between Enova Corp. and Pacific Enterprises, the respective parents of San Diego Gas & Electric and SoCal Gas. Reliant ranks seventh this year, rising five places from Houston Industries 12th position. Sempra moves into the 19th slot, vacating Enova`s previous 39th position.

Except for Dominion mentioned above, the top ten positions in total revenues look similar to last year`s ranking. The two major gainers in the top positions were TXU, going from last year`s eighth position to this year`s fourth, and UtiliCorp, rising from seventh to fifth. Southern Co. and Entergy were displaced, falling from fourth and fifth to eighth and sixth, respectively. Conversely, Edison International fell from sixth to ninth.

Regarding return on equity (ROE) rankings, IPALCO continues a strong performance, occupying first place this year, second last year and ranking sixth in three-year ROE average. UniSource Energy took first place in the three-year ROE ranking, largely by virtue of outstanding ROE figures for the last two years. By the same token, however, UniSource`s 12-month ROE percentage fell more than any other company in the period from March 1998 to March 1999.

PECO`s equity returns rank second overall, rising from 11.6 percent last year to 22.4 percent in the 12 months ending March 1999. The company has been a strong performer in recent years, holding the No. 5 position in both two-year change and three-year average returns. PECO posted a very strong, 10.8 point rise from March 1998 to March 1999, and its three-year average ROE is a healthy 1.46 percent.

Other ROE leaders are fourth-place PP&L Resources and fifth-place OGE Energy. OGE`s ROE rose from 13.6 percent last year to 18.7 percent this year, and the company holds a fifth-place, three-year average of 15.4 percent. PP&L occupies the eighth position in the three-year average ranking and has the third-highest two-year increase in ROE. PP&L`s equity returns more than doubled from 9.8 percent last year to 21.3 percent this year.

The most disappointing ROE figures were posted by Niagara Mohawk and Northeast Utilities, which ranked dead last in this year`s ranking as well as the three-year average.

Northeast Utilities aims to turn its situation around by adding energy products other than electricity to its portfolio, and by becoming a major energy trader in the New England region.

NiMo sees light at the end of the tunnel with its successful resolution last year of its burdensome, above-market power purchase obligations. NiMo also is undergoing a restructuring, divesting its non-nuclear generating assets and establish- ing a competitive retail electricity market.

Illinova joins NiMo and Northeast Utilities with negative ROE numbers. The main reason for Illinova`s nearly $1.4 billion loss was the $1.33 billion write-off of its Clinton nuclear power plant. Even considering this extraordinary event, however, Illinova`s 1998 operating results were “among the worst in the company`s history”, according to CFO Larry F. Altenbaumer. In the wake of the write-off, an accounting restructuring is expected to give Illinova a fresh start. Its planned merger with Dynegy could also contribute to renewed hopes.

Leveraging growth

Along with the industry`s move toward more speculative business areas is the increase of debt financing to fuel these ventures. According to Navigant Consulting`s Electric Utilities FlashReport, the utility industry`s debt ratio increased by 10 percent in the last two years. Since 1996, utilities raised eight times more debt financing than they did equity.

PECO, IPALCO, MidAmerican, Puget Sound Power & Light and Illinova had the five largest increases in debt load in the last two years, according to Metzler. These increases came from new debt issues, stock buybacks, liability write-offs and new business investments.

The biggest decreases in debt ratios were seen by New England Electric System (NEES), Otter Tail Power, FPL Group, Northwestern Corp. and BEC Energy. Their decreases came from debt retirements and sales of assets to fund debt buy-downs.

The companies with the lowest debt ratio in the 12 months ended March 31 were FPL, MarketSpan Corp., WPS Resources, Montana Power and NEES. Four of the most debt-free companies carried less than 40 percent debt loads. All of the top 15 were leveraged less than 44 percent, compared to an industry average of 53.5 percent.

Conversely, the most heavily indebted 15 companies were all over 60 percent leveraged. The five companies with the highest debt ratios were between 70.3 and 89.5 percent leveraged. The most indebted company was UniSource, followed by MidAmerican, AES, CMS and PECO.

Interestingly, all five of the most indebted companies are considered healthy and vibrant by most standards. Their debt level comes from their approaches to business development. UniSource invested in New Energy Ventures (which is being acquired by AES) and develops private power plants globally through its Nations Energy subsidiary. MidAmerican includes CalEnergy`s portfolio of project-financed power plants, as well as its leverage from acquiring MidAmerican and such other assets as the Northern Electric REC in the United Kingdom. Likewise, AES and CMS leverage their project developments as much as possible, and PECO`s debt largely comes from securitization of its stranded costs, plus business developments by AmerGen and Exelon.

These facts highlight a common misconception, especially among new initiates to the industry. Debt is not, by definition, a bad thing. Debt securities typically provide a much cheaper financing source than equity. Where equity stocks command equity returns, such instruments as revenue bonds can raise cash for interest rates in the single digits. This equals low-cost capital to fuel growth.

Excessive leverage can, of course, be a problem, especially when market conditions take a turn for the worse. But generally speaking, a company that raises debt financing is a company that`s going places.

Editor`s note: The data for this report were provided by Navigant Consulting Inc. of Springfield, Ill. The Navigant Knowledge System for the electric and gas industries contains financial, operating and demographic information for investor-owned electric utilities and operating/power supply data for over 3,000 public power utilities and cooperatives. NKS also includes complete financial and operating data for gas pipelines and source and use data for over 2,000 IOU and municipal LDCs.

Contact: Samuel L. Xanders, Director, Navigant Consulting Inc., 3900 Wood Duck Drive, Ste. D, Springfield, IL 62707 / Phone: (217) 241-1450 / Fax: (217) 241-1459 / email:

Navigant Consulting Inc. (formerly Metzler Group Inc.) is located at 615 N. Wabash, Chicago, IL 60611 / Phone: (847) 945-0001 / Fax: (847) 945-0240 / Email:

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ELP analysis: A higher ratio of electric retail sales to total revenue results in diminishing stock market value.

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