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Fragile Foundation

The capital markets have recovered … or have they?

Fortnightly Magazine - October 2009

Industrial Index. That said, they also haven’t recovered as well. Within that, the stocks that were most hurt during the contagion were those that had more sensitivity to commodity prices—companies with large wholesale generation fleets. They underperformed the other utilities on the downswing and have outperformed them on the upswing.

Yield is an important component of investor perceptions of utility valuations. Utilities are regarded as income stocks. Some believe utility stocks are poised to outperform as their dividend yields are higher than the sector’s bond yields, and price-earnings ratios are compelling vs. the overall market.

On the other hand, many investors are skeptical about growth with significant declines in industrial demand.

In terms of new issuance, we’ve seen the return of utility common stock dribble programs, where utilities issue stock continuously to reduce market-access risk and manage price volatility. More traditional issuance activity is being driven from rate-base growth, environmental cap-ex and transmission spending.


Volatile Access

Fortnightly: How have merchant power and midstream gas companies weathered the financial crisis? How do the capital markets look for them?

Bilicic: Unlike in 2002 and 2003, the non-regulated components of the energy industry have been relatively stable as compared to other parts of the economy. We haven’t seen the sorts of restructuring activity levels that we have seen elsewhere. Companies in this area have solid capital markets access at the moment, but should be mindful of the volatility of that access.

Nastro: Our industry has been able to finance throughout the cycle. High-yield rates reached their all-time high in December 2008, and since then spreads have tightened dramatically. Both Calpine and NRG have been able to issue high-yield debt at coupon rates better than 9 percent, which speaks to the way the utility space is perceived and differentiated within the high-yield investor universe.

In terms of leveraged loans and loan maturities, if you look out through 2011, not a lot of refinancing needs to be done. But a wave of debt maturities begins in 2012, as financial sponsors begin to refinance debt from recent leveraged buyouts. For example, Energy Future Holdings, the former TXU, faces material maturities beginning in 2013 and 2014.

At this point, the leveraged loan market is still in disarray and may be for some time to come, because the primary buyers—the CLO investors and hedge funds—have seen significant investor redemptions, and that will result in continued market contraction.


Fortnightly: What’s the outlook for mergers and acquisitions? If the financial storm is passing, will consolidation resume?

Bilicic: We see all the fundamentals coming into place where there would be robust consolidation, except that, given the way this industry is regulated, it’s difficult for companies to pursue consolidation. In particular, the intense rate-case cycle that many companies are in right now will slow the emergence of any consolidation trend. On average, we should see between three and five notable transactions a year. M&A activity was dormant last fall and winter, because, among other things, it was difficult to know what relevant parties were worth in the environment. But now with