Like a physician with her stethoscope at the outset of a check-up, astute shareholders and directors should use the level and trend of a utility’s market-to-book ratio (MtB) as one of the first...
The Path Forward
In the wake of the banking crisis, utilities lead the way to financial stability.
In mid-September, as this issue was going to press, a storm was raging on Wall Street. From Lehman’s bankruptcy and acquisition by Barclays, to the transformation of Morgan Stanley and Goldman Sachs into full-fledged banks, to the historic nationalization of U.S. mortgage debt, the financial landscape was changing at a bewildering pace.
But despite the tumult on Wall Street, many of the things that were true about access to capital for U.S. utility companies on September 1 remain more or less true on October 1 and November 1—except now they’re doubly true, in spades, with big exclamation points.
Namely, a handful of factors will determine the terms on which companies in this sector can raise capital—credit quality, liquidity, the ability to generate cash flow, and support from industry regulators.
These factors always have differentiated winners from losers in the U.S. electric power and gas industry, and that hasn’t changed. The stakes of the game, however, have changed—with losers facing dire choices ( i.e., Constellation Energy’s rescue by MidAmerican Energy). Fortunately, however, most companies in this sector find themselves in reasonably good shape for accessing debt and equity financing. In this uncertain and volatile market, capital will flow first toward the most stable and secure investments—such as power plants, transmission lines and rate-regulated utility operations.
“Recent market turmoil has been driven by concerns about liquidity and systemic risk, rather than fundamentals,” says David Nastro, managing director of Morgan Stanley’s global power group. “The current market isn’t indicative of the sector’s ability to raise capital. As we return to a more normal new issue environment, the utility industry will lead the way as investors focus on strong credits, with long-lived hard assets and solid cash flows.”
Moreover, the Enron crisis now appears to have been a blessing in disguise, because it forced companies in this industry to purge their bad debt, putting them in a strong position as the post-Lehman era begins (see Figures 2, 3 and 4) .
“In this environment, utilities now are enjoying the benefits of back-to-basics strategies,” says James Hempstead, a vice president and senior credit officer with Moody’s Investors Service. “Back-to-basics strengthened the resiliency of their business plans and made them a good port to harbor for investors.”
The industry’s relative stability, combined with the country’s growing concern about energy issues, might lead toward an historic investment in power and gas infrastructure.
At the same time, however, the industry faces game-changing risks. No one can know whether the federal mortgage bailout will restore long-term confidence to the capital markets on which power and gas companies depend. And even if the bailout works, financial institutions might decide some of the services they’ve provided to energy and utility companies are now too risky and capital intensive for the profits they deliver.
The result could be a major upheaval in the way the industry finances operations and participates in energy markets.