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Fragile Foundation

The capital markets have recovered … or have they?

Fortnightly Magazine - October 2009

price-earnings multiples. The market isn’t differentiating companies in the sector now based on their business models, and that speaks to the uncertainty in the economic backdrop. People don’t know how long this recession will last, and therefore they’re reticent to make long-term bets on either the regulated or hybrid names.

Bilicic, Lazard:  If you’re an investment-grade credit in this industry, you should have good access to the capital markets over time, although companies need to be prepared for intermittent events that impede access to capital markets. If you’re a non-investment grade credit, it’s much more important to prepare for capital-markets intermittency.

The bank market is more challenging than accessing the capital markets; terms and pricing are difficult. Also, because there are fewer active lending institutions, they have a much more significant influence on terms than in the past. Renewal risk is a concern in the commercial banking market over the next few years.

Wood, Credit Suisse:  All the financing markets have recovered dramatically, after being shut for all intents and purposes in the 4th quarter of 2008. The bank market has adjusted to the departure of Lehman and a few European institutions. It’s a much healthier market than it was 10 or 12 months ago. While spreads have widened and tenors have declined, utility bank syndications are progressing.

In terms of utility equity issuance, activity is down as utilities have deferred capital investments and managed their cash flow profile.


Fortnightly: Should we expect a wave of new equity issues from utilities to begin now?

Nastro: As it relates to new equity issues, two themes are emerging. One is based on the glass half-empty viewpoint. The industry needs to finance significant ongoing capital expenditures, costs of capital are increasing and, given the economic uncertainty, companies face a challenging regulatory environment. The glass half-full viewpoint sees that utilities have been able to issue through this entire cycle. The capital markets are open, investment funds are growing and dividend-paying stocks are still in demand. There continues to be a fundamental tension between these two competing viewpoints.

From the buy side, we’ve been getting a number of questions. Why haven’t we seen more equity new issues from utilities? If the market window is open now, why aren’t companies issuing equity as they look at the enormous amount of capital they need to raise in 2010 and 2011?

Part of the answer is there’s a returning focus on earnings per share. If we’re coming out of the recession quickly, then buy-side investors will return their focus to EPS growth vs. balance-sheet strength. Companies coming out of this cycle don’t need the capital immediately and are delaying their equity issuance to mitigate EPS dilution and enhance EPS growth.

People are looking to third-quarter earnings as a litmus test to see whether the market rally is sustainable and whether we should expect a recovery in the first half of 2010.

Wood: The risk-return construct continues to favor utilities in down markets. Utility stocks did well through the contagion. They didn’t fall as far as the Dow Jones