AGA/EEI Accounting Leadership Conference The Good Times May Be Ending! EQUITY RESEARCH Daniel F. Ford, CFA +1 212 526 0836 [email protected]Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Customers of Barclays Capital in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-253-4626 to request a copy of this research. Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 35. Power & Utilities June 2009
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Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.
Customers of Barclays Capital in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-253-4626 to request a copy of this research.
Investors should consider this report as only a single factor in making their investment decision.
PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 35.
Power & Utilities
June 2009
2
2H’09: The Power & Utilities Landscape
What the Market is Focused On:
3
2H’09 – What Now?
Source: FactSet, Barclays Capital estimates
The recession, which began in 4Q07, caused an unwind of the long power/short regulated utility trade. Power regained leadership in April. Two questions remain: Is it too late to buy defensive regulated utilities?Is it too early to buy power?
Cumulative Relative Performance vs. UTY (2001 - Present)
-30.0%
-20.0%
-10.0%
0.0%
10.0%20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
May-092Q082Q072Q062Q052Q042Q032Q022Q01
Regulated Power
Power leadsUteslead
Power leads?
4
Too Late For Utilities? Is the Recession Over?
Source: FactSet, Barclays Capital estimates
Historically, regulated utilities begin to outperform six months prior to, and then throughout, recessions. Barclays Capital believes the recession ends in 3Q09.
2.4%1.5% 1.9%
3.4%
5.5%
-5.4%
-6.7%
-8.0%
-10.0%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
6 Months Prior 3 Months Prior 3 Months In 6 Months In Span ofRecession
3 Months After 6 Months After 12 MonthsAfter
Absolute Relative to S&P 500
Utility Performance Through Recessions
5
Historically, the market has paid up for quality going into, and in the early stages of, a recessionLower quality, smaller names usually outperform as we emerge
Group 2010 P/E Current P/BV Dividend Yield Payout RatioHigher Quality 10.9x 1.4x 5.6% 64.8%Lower Quality 9.5x 1.1x 5.9% 57.7%
Source: FactSet, Barclays Capital estimates.
7
Is It Too Early for Power?
We believe the inflection in two key Power catalysts have taken place.Natural Gas prices have likely bottomedHigh yield credit spreads have likely bottomed
Significant uncertainty remains in two other drivers needed to confirm a sustainable recoverySupply/demand conditions still deterioratingPolicy uncertainty still great for polluters
8
Gas Bottoms by Summer’s End; Surprise Bias for 2010/11 Is Up
56
57
58
59
60
61
62
63
64
65
2006 2007 2008 2009 2010
Supply Demand
US Aggregate Supply and Demand (Bcf/d)
y/y change
2008
Bcf/d
y/y change
2009
Bcf/d
y/y change
2010
Bcf/d
US Supply 3.99 0.29 -3.58
Canadian exports to
US
-0.81 -1.13 -0.50
LNG -1.15 1.18 1.08
Total Supply
1.80 0.43 -3.00
Total demand
0.35 -1.53 0.32
Price outlook $8.90 $4.10 $6.50
Source: EIA, Barclays Capital
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Source: LehmanLive, Barclays Capital.
High Yield Credit Has Improved Dramatically – Leading IPP Higher
Possible Impacts of Federal Cap and Trade – Waxman / Markey
Impacts of Federal Carbon RegulationTotal Transition Year Open Estimated Current Estimated
Ticker 2013 Total Production - Unregulated Mkts, by Fuel (MMWh) (M Tons) Upside Upside Per Share 5/29/2009 % of PriceCoal Gas / Oil Nuclear Hydro CO2 Produced EPS EPS Open NPV Stock Price Open NPV
Notes: Renewable energy sources such as geothermal, solar and wind are excluded to avoid double-counting of PTC benefitsTransitional effects reflect hedges currently in place, while "Open" figures ignore extant contracts
We believe longer-term capital expenditure cycle will likely lead to Regulated Utility performance differentiation based on strength of balance sheet, quality of regulatory jurisdiction and focus of strategy.
15
Long Term: Capital Cycle May Have Negative Consequences
A robust capital spending program for regulated utilities is underway and will likely introduce multi-year cash flow issues.
We believe the need for external capital funding is likely to stay at a heightened level.
Rate Case frequency and sizing of requests should increase, which will likely cause a squeeze in returns and increase problems with lag.
Strong balance sheets, favorable regulatory jurisdictions and focused strategy will likely outperform, in our view.
16
CapEx and Rate Base Growing
Environmental compliance, renewables and transmission spending appear to be driving investment.
Spending will likely remain elevated into the next decade.
Capital Expenditure ProjectionsShareholder Owned Regulated Utilities($ in millions)
Note: Figures reflect Barclays Capital utility coverage scaled up by a factor of 1.08x to reflect companies not in Barclays coverage universe.
Source: Company filings, Barclays Capital estimates.
Rate Base Growth ProjectionsShareholder Owned Regulated Utilities($ in millions)
2006 2007 2008 2009E 2010E 2011E 2012ERate Base $435,724 $416,406 $452,887 $492,211 $524,342 $556,167 $587,629Capital Expenditures $55,258 $63,154 $58,293 $60,403 $62,542 $63,726D&A $23,527 $23,831 $26,162 $28,578 $31,080 $33,629Rate Base Additions $31,731 $39,324 $32,131 $31,825 $31,462 $30,097Rate Base Growth % 7.3% 9.4% 7.1% 6.5% 6.0% 5.4%Source: Company filings, Edison Electric Institute, Barclays Capital estimates.
17
Negative FCF Will Likely Require Heightened Debt/Equity Funding
Assuming mild near-term growth in CFO and 3% growth in dividends, FCF should stay negative through 2012. As balance sheets are stretched, equity issuance will likely return to the fore.
Capital and Cash Flow ProjectionsShareholder Owned Regulated Utilities($ in millions)
Short-Term Inflation Reprieve May Lead to Better Regulatory Outcomes
Note: Figures reflect Barclays Capital utility coverage scaled up by a factor of 1.08x to reflect companies not in the Barclays Capital coverage universe. Units are in millionsSource: FactSet and Barclays Capital estimates.
Capital requirements should increase the number of rate cases, causing greater lag.
Longer term, outcomes still likely impacted by less rosy inflation scenario
ROE Spread vs. Pre-Dividend FCF
($20,000)
($15,000)
($10,000)
($5,000)
$0
$5,000
$10,000
$15,000
$20,000
$25,000
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
E
2011
E
2013
E
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
Pre-Div FCFin 2008 $'s
Actual less Allowed ROE
zero spread
21
…While the Market Will Likely Demand Higher Returns
Note: Figures reflect Barclays Capital utility coverage scaled up by a factor of 1.08x to reflect companies not in the Barclays Capital coverage universe and units are in millionsSource: FactSet and Barclays Capital estimates
Due to the myriad risks resulting from a capital cycle, a higher risk premium should apply.
Free Cash versus Equity Risk Premium
($20,000)
($15,000)
($10,000)
($5,000)
$0
$5,000
$10,000
$15,000
$20,000
$25,000
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
E
2011
E
2013
E
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
Pre-Div FCF in 2008 $'s
Implied Equity Risk Premium
XEL Equity: 487 bps risk prem. to 10-Yr. (9/9/08)
POM Equity: 921 bps risk prem. to 10-Yr. (11/6/08) PGN Equity: 736 bps risk prem. to 10-Yr. (1/7/09)
POR Equity: 947 bps risk prem. to 10-Yr. (3/5/09)
NU Equity: 620 bps risk prem. to 10-Yr. (3/16/09)
AEP Equity: 921 bps risk prem. to 10-Yr. (4/1/09)
22
Quality of Regulation a Likely Differentiator
Below are the results of our quantitative and qualitative ranking of state and federal regulators:
Money should flow to the best locations – we believe companies with highest customer satisfaction results also generally enjoy the best relative values versus the group.
Relative Price-Book Valuation of Electric Utilities by Region(1986-Current, weekly)
Three of five drivers to Power bull market taking a breather
Three drivers in hibernation or in decline: Marginal fuel rates for coal Supply/demand balance Direction of new entry costs
Two showing signs of recovery: Marginal fuel rates for natural gas Government policy on pollutants/CO2
26
The Fundamental Forecast
Forecast shows heat rate declines in 2008-2010, before rising through end of forecast Weak US economy prime driver to forecast change Higher than previously anticipated wind additions exacerbate situation New reserve margin and fuels outlook skew leaders and laggards
New power plants needed beyond 2015 versus 2010/12 previously Spark spread negatively impacted Midwest region looks challenging for some time
Relative strong outlook for natural gas versus coal price through 2011 Expands dark spread
Quark spread holds up well in our outlook
27
US Economy in Recession Electrically
Source: Edison Electric Institute.
Demand weakened in most regions through May 09 – soft economy, cost inflation combine to curb growth.
Weather Adj. Output Changes - Quarterly by Region
-6.5%
-4.5%
-2.5%
-0.5%
1.5%
3.5%
5.5%
7.5%
9.5%
US
Tot
al
Sou
th C
entr
al
Roc
ky M
tn
Sou
th E
ast
New
Eng
land
Mid
-Atla
ntic
Cen
tral
Ind
Wes
t C
entr
al
Pac
ific
N'W
est
Pac
ific
S'W
est
Q1 '08 Q2 '08 Q3 '08 Q4 '08 Q1 '09 Q2 '09 (2 mo.)
28
Natural Gas Outlook
Natural Gas Forward Estimates
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
$7.00
$7.50
$8.00
2009 2010 2011 2012 2013
NYMEX Strip Barcap Power & Utilities Research Market Implied (Spark Spread Quarterly)
Open EBITDA at 7.9x, above mid-cycle 7.1x Open EBITDA below hedged EBITDA Coal generators have exposure to Dark Spread compression and environmental
policy shift
DCF of plant margins shows 17.6% decline in values from September 2008 update Peaker values down most (31% on average) Coal values not far behind (down 27% on average) Nuclear and renewables down 11-12%
Market prices do not appear high enough to give new build incentives, in our view; weak heat rate forecasts suggest this condition will likely persist in the medium term.
33
Solar & Wind Resource Potential
Source: U.S. Department of Energy, AWEA, Barclays Capital
34
New Transmission Lines Required
Source: U.S. Department of Energy, AWEA, Barclays Capital
2
35
Analyst Certification and Important Disclosures
Analyst Certification:I, Daniel Ford, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important DisclosuresBarclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.
Customers of Barclays Capital in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-253-4626 to request a copy of this research.
Investors should consider this communication as only a single factor in making their investment decision.
The analysts responsible for preparing this report have received compensation based upon various factors including the Firm's total revenues, a portion of which is generated by investment banking activities.
For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to the firm's disclosure website at www.lehman.com/disclosures. On September 20, 2008, Barclays Capital acquired Lehman Brothers' North American investment banking, capital markets, and private investment management businesses. We have endeavored to provide conflicts of interest disclosures on a combined basis. All ratings and price targets prior to the acquisition date relate to coverage under Lehman Brothers Inc.
Other Material Conflicts:Dynegy: Barclays Capital is acting as financial advisor to Dynegy on the potential sale of two non-core power plants.Exelon: Barclays Capital is acting as financial advisor to Exelon Corporation (EXC) in its offer to acquire NRG Energy Inc (NRG).
Guide to Barclays Capital Fundamental Equity Research Rating SystemOur coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (“the sector coverage universe”). To see a list of companies that comprise a particular sector coverage universe, please go to www.lehman.com/disclosures.In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.
36
Important Disclosures (Cont’d)Stock Rating1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable or to comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisory capacity in a merger or strategic transaction involving the company.Sector View1-Positive - sector coverage universe fundamentals are improving. 2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating. 3-Negative - sector coverage universe fundamentals are deteriorating.Distribution of Ratings:Barclays Capital Equity Research has 1217 companies under coverage.
36% have been assigned a 1-Overweight rating which, for purposes of mandatory disclosures, is classified as a Buy rating, 39% of companies with this rating are investment banking clients of the Firm.
48% have been assigned a 2-Equal weight rating which, for purposes of mandatory disclosures,is classified as a Hold rating, 32% of companies with this rating are investment banking clients of the Firm.
14% have been assigned a 3-Underweight rating which, for purposes of mandatory disclosures, is classified as a Sell rating, 23% of companies with this rating are investment banking clients of the Firm.
Barclays Capital offices involved in the production of Equity Research:
LondonBarclays Capital, the investment banking division of Barclays Bank Plc (Barclays Capital, London)
New YorkBarclays Capital Inc. (BCI, New York)
TokyoBarclays Capital Japan Limited (BCJL, Tokyo)
São Paulo Banco Barclays S.A. (BBSA, São Paulo)
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Important Disclosures (Cont’d)This publication has been prepared by Barclays Capital; the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. This publication is provided to you for information purposes only. Prices shown in this publication are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell any financial instrument. Other than disclosures relating to Barclays Capital, the information contained in this publication has been obtained from sources that Barclays Capital believes to be reliable, but Barclays Capital does not represent or warrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject to change, and Barclays Capital has no obligation to update its opinions or the information in this publication. 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