Note: New material since last update is highlighted, otherwise there are no changes.
Overview
The Public Utilities Commission of Nevada’s significant general and deferred energy rate increases favor Sierra Pacific Resources, however, the $400M in terminated power contract claims (e.g., Enron) tagged with a likely lengthy appeals process, and a load of expensive debt are a burden on the company. The three Street analysts following SRP unanimously agree on a ‘Neutral’ rating with a single target price of $9.
Key Positive Arguments / Key Negative Arguments* Significant operating EPS improvements expected following the recent increase in rates granted to both NPC and SPPC / * Enron’s terminated power contract claims, which may drag on for a while, exceed $400 million. A $300M write-off after-tax would reduce SRP’s book value by $1/share.
* The PUCN approval for the acquisition of the 1,200 MW Moapa Energy Facility from Duke Energy with an additional 2 percent return on equity on construction costs. / * Inability to earn adequate ROE at NPC and SPPC
* Improved financial position since approaching liquidity crisis and/or bankruptcy in 2002 / * Weak balance sheet
* Increasing sign of regulatory support / * High debt levels & high cost-of capital
* PUCN approved the construction of SRP’s new generation facilities (80MW combustion turbine in 2006 & 520MW CCGT in 2007). / * With below investment-grade credit ratings, SRP must rely on state regulators to act responsibly on cost recovery and rate of return requests i.e., general rates and deferred energy cases) to realize true potential
* Overcoming regulatory lag and earning on rate base additions remain key variables / * Dilution via $300 million parent note maturing in May ‘05
* Attractive relative valuation / * Unfavorable wholesale power price movements
* If NPC and SPPC are required to pay judgments of approximately $235million and $103million, respectively, or post additional cash collateral for Enron’s claims for termination payments, it could adversely affect SRP’s cash flow, liquidity and financial condition and would render the company’s ability to operate outside of bankruptcy uncertain.
* Unfavorable weather
Sierra Pacific Resources
Reno, Nevada-based Sierra Pacific Resources (NYSE: SRP) is an energy and utility holding company. Through its principal utility subsidiaries, Nevada Power Company (NPC) and Sierra Pacific Power Company (SPPC), SRP engages in the generation and distribution of electricity, and the transmission and distribution of natural gas. Collectively, the utilities service nearly 1 million electric customers over a 54,500 square mile service area covering most of Nevada, including Las Vegas and Reno, plus the Lake Tahoe region of northern California. Another subsidiary, the Tuscarora Gas Pipeline Company, owns and operates a 50-percent interest in an interstate natural gas pipeline from Malin, Oregon to Reno, Nevada. The Company’s other wholly-owned subsidiaries include Sierra Pacific Communications, Sierra Pacific Energy Company and Lands of Sierra are engaged in telecommunications, energy-related and real estate businesses.
During Q2’02, citing SRP’s weakened financial condition, the Company’s Board of Directors indefinitely suspended the quarterly common stock dividend.
Nevada Power Company
NPC engages in the distribution, transmission, generation, purchase, and sale of electric energy in Clark County in southern Nevada. NPC provides electricity to approximately 669,000 customers in the communities of Las Vegas, North Las Vegas, Henderson, Searchlight, Laughlin, and adjoining areas, including Nellis Air Force Base. Service is also provided to the Department of Energy's Nevada Test Site in Nye County. NPC's service territory continues to be one of the fastest growing areas in the nation, with residential customer growth averaging 5.3% per year over the past 5 years. A significant part of the growth in NPC's electric sales has resulted from new residential, industrial, and gaming customers.
Sierra Pacific Power Company
SPPC engages in the distribution, transmission, generation, purchase, and sale of electric energy. It provides electricity to more than 318,000 customers in an approximately 50,000 square mile service area in western, central and northeastern Nevada, including the cities of Reno, Sparks, Carson City, and Elko, and a portion of eastern California, including the Lake Tahoe area.
SPPC's natural gas business provides natural gas service, through a local distribution company (LDC), to approximately 123,500 customers in about 600 square miles in the Reno/Sparks region of Nevada. At FYE’02, SPPC owned and operated 1,693 miles of natural gas distribution pipeline. Growth in SPPC's LDC service territory continues to be strong.
In June 2001, SPPC exited the water utility business, divesting assets to the Truckee Meadows Water Authority (TMWA) for $341 million.
General & Deferred Energy Rate Cases
Sierra Pacific Resources generates a significant portion of earnings from its stable regulated utility operations. In fact, the service territory of NPC continues to be one of the fastest growing areas in the nation, with residential customer growth averaging 5.3% annually over the past five years. Moreover, the company has been granted several arte hikes, which will help boost future earnings. Specifically, PUCN allowed NPC a $45 million increase in its annual rates, in addition to the recovery of approximately $169 million in deferred energy and fuel costs (to be collected over the next several years). Besides, SRP has also been recently granted a $46.7 million rate increase and has been allowed to recover half of the costs ($48 million) associated with the construction of the experimental coal and gasification plant.
Besides, SRP has recently received approval from the Public Utilities Commission of Nevada (PUCN) for the acquisition and financing of a partially constructed 1200 MW natural gas-fired combined- cycle power plant located in the Moapa Valley, 20 miles northeast of Las Vegas. The total cost to acquire and complete construction of facility has been estimated at $558 million. The PUCN's final order deemed the plant a critical facility and provided the company with an additional 2 percent return on equity on construction costs. The facility consists of four natural gas-fired combustion turbines, two steam turbines and four heat recovery steam generators operating in combined-cycle mode. It is expected to be fully operational by the summer of 2006.
Terminated Power Contract Claims
SRP’s utility subsidiaries, NPC and SPPC, and Enron Power Marketing, Inc., a subsidiary of bankrupt Enron Corp., remain entangled in litigation in the U.S. Bankruptcy Court for the Southern District of New York. Enron claims that it is owed $338M by SRP’s utilities for terminated power contracts and related interest expense. While judgment has been stayed while it is appealed, this claim and other terminated power contract claims of $99M before interest could result in sizeable potential cash outlays that could strain SRP’s weak finances.
On October 16, 2003 SRP’s utilities filed a complaint at the U.S. Federal Energy Regulatory Commission (FERC) to prevent bankrupt Enron Power Marketing, Inc. from obtaining a final judgment -- pending FERC review -- involving more than $330 million from "unlawful termination payments." The filing is intended to address Enron's purported "early termination" of power contracts with SRP's Nevada utilities in a maneuver that would provide a "windfall" to Enron by obtaining payment for electric power that Enron did not, nor could not, provide. The formal complaint describes the "great harm" that could be done to the SRP utilities as well as the citizens of Nevada should any money be paid to Enron — pending appeals and FERC review — while Enron enjoys bankruptcy protection.
Recall that in early 2003, the FERC found Enron to have unlawfully manipulated the Western energy market, engaging in fraud, deception and other actions that created “unjust and unreasonable” power market prices. Prior and subsequent to this FERC ruling, numerous Enron employees pled guilty to related criminal charges.
The Enron subsidiary has been seeking the posting of collateral from SRP for claims related to the contracts that had been terminated by Enron in early 2002. On November 6, 2003 the Bankruptcy Court ruled on the amount and types of collateral that SRP's utilities will be required to place in escrow, pending their appeal of the court's previous decision involving the dispute with Enron over $336M in terminated power contracts. Judge Arthur Gonzalez's ruling stays execution of the court's previous decision in favor of Enron through the posting into escrow by the SRP utilities of $338M of General and Refunding bonds secured by the companies' assets plus approximately $280,000 in cash for prejudgment interest. Additionally, the SRP utilities will pay $35M in cash to escrow 90 days after the date of the final stay order. The alternatives were 100% cash or $125M in cash over several months, either of which could have lead to SRP's own Ch.11 process. The judge added that the court would review conditions related to the order approximately two weeks after the payment of the $35 million in cash collateral.
The judge's ruling on collateral enables SRP to avoid a certain liquidity crisis, and a potential Chapter 11 bankruptcy. The decision also provides SRP the opportunity to proceed with the appeal process in Federal District Court. Nevertheless, the collateral requirement will likely force SRP to further lever-up the utility subsidiaries during the appeal process. SRP maintains that it should not be required to pay Enron unprecedented high prices, largely caused by Enron's manipulation of the energy market, for power that was never delivered. Further, SRP cites prior FERC rulings having found Enron guilty of price manipulation, and accordingly, remains confident that SRP’s position will be upheld on appeal. On July 22, 2004 the FERC granted the utilities’ request for an expedited hearing and a final order is expected by 2004-end.
Sales
SRP generates revenue through 3 primary business segments: Electric, Gas and Other.
The SRP Street consensus model of 3 brokerage analyst models forecasts total revenues of $2.87B in FY’04 and $2.96B in FY’05. This represents an estimated compound annual growth rate of +3.0% from realized FY’03 revenues. This is also consistent with YoY sales growth of +3.0% in FY’04 and +3.0% in FY’05.
($ in millions) / FY'03A / FY'04E / FY'05E / Est. CAGREst. Total Revenues / $2,789 / $2,873 / $2,959
YoY Growth / 3.0% / 3.0% / 3.0%
For more color on SRP’s revenue by segment, reference the ‘Consensus Model’ tab of the SRP spreadsheet.
Margin
The only material issue relating to SRP’s margins in current reports is the Nevada Public Utilities Commission’s final decision of the authorized ROE that SRP will be allowed to earn on its recently acquired partly constructed Moapa power plant from Duke Energy.
For more color on SRP’s margins, reference the ‘Consensus Model’ tab of the SRP spreadsheet.
Earnings per Share
With no earnings guidance from management, the Street consensus EPS estimate for FY’04 is $0.38 and for FY’05 is $0.52.
(US$) / FY'03A / FY'04E / FY'05E / Est. CAGRConsensus EPS estimates / -$0.37 / $0.38 / $0.52 / NM
YoY Growth / NM / 34.8%
Low est. / -$1.15 / $0.35 / $0.45
High est. / $0.16 / $0.45 / $0.55
FY’04 EPS estimates come in at a low of $0.35 (Lehman, Merrill) and a high of $0.45 (AG Edwards). FY’05 EPS estimates come in at a low of $0.45 (Lehman) and a high of $0.55 (AG Edwards, Merrill).
Regarding the historical accuracy of analysts following SRP, based on the average number of months per year (from 2000 through 2003) that SRP analysts beat the Street consensus estimate, the (AG Edwards) analyst has the most accurate record at 7.5 months, followed by (Lehman) at 4.7 months and (Merrill) at 4.3 months.
NPC is currently earnings well below its allowed ROE of 10.1%. If both SPC and NPC were to earn an allowed 10.1% ROE (a possibility only if the Commission allows them full recovery of all costs), the (Merrill Lynch) analyst continues to estimate the company’s earnings power in the $0.55-$0.60/share range. Additionally, the Moapa power plant is expected to be the earnings driver going forward. Based on the staff recommendation of a 13.25% ROE on the plant, the analyst estimates that earnings could potentially increase by $0.20/share.
Similarly, the (Lehman) analyst observes that SRP would be allowed a baseline 200 bps incentive above the 10.25% allowed ROE on the 1200 MW Moapa plant. The company’s theoretical EPS power is expected to be $0.75 in 2006.
The (AG Edwards) analyst estimates that a 300 bps incentive return on the $367.6 million Moapa power plant would add $0.02 to SRP’s annual earnings.
For more color on EPS forecasts by individual analysts, reference the ‘Consensus Model’ tab of the SRP spreadsheet.
Target Price/Valuation
The three Street analysts following SRP unanimously agree on a ‘Neutral’ rating with a single target price of $9.
Rating DistributionPositive / 0%
Neutral / 100%
Negative / 0%
Avg. Target Price / $9.00
Low TP / $9.00
High TP / $9.00
For more color on valuations & ratings by individual analysts, reference the ‘Valuations & Ratings’ tab of the SRP spreadsheet.
Long-Term Growth
Only the analyst from (Merrill Lynch) publishes a long-term growth estimate of 3.0% for SRP.
Events Calendar
Date / Event / CommentsEnd-2004 / Decision on the ongoing litigation with the Enron Corp.