Note: This report contains substantially new materials. Subsequent reports will have changes highlighted.
Reason for Report: 1Q07 Results (Previous: Change in Estimates, April 18)
Recent Events
On April 26, 2007, PSD reported 1Q07 financial results, with EPS of $0.68 compared to $0.63 in 1Q06. The quarter’s results were essentially inline with “Street Consensus”. Management expects to record EPS in range of $1.50 to $1.65 in 2007.
Overview
Bellevue, Washington based Puget Energy, Inc. (PSD) is an energy services holding company that principally operates through its subsidiary Puget Sound Energy. Puget Sound Energy (PSE) is a utility company engaged primarily in the transmission and distribution of electric and natural gas to residential and commercial customers within WashingtonState. Puget Sound Energy contributes the major share of the company’s revenue, and furnishes electric and gas services in a territory covering 6,000 square miles serving approximately 1 million electric customers and 683,000 natural gas customers. It employs nearly 5,300 people. PSE also generates electricity using hydro-powered, natural gas fired plants and coal plants. PSD reports its revenue through Electric, Gas, and Corporate and Other segments. For more information on the company, please visit its website at The current quarterly dividend rate is $0.25 per common share.
Key Positive Arguments / Key Negative Arguments- PSD made an increase in natural gas rates under the purchased gas adjustment (PGA) mechanism, which allows the company to recover higher gas costs.
- The company’s electric margins have increased due to favorable ruling by WUTC (Washington Utilities and Transportation Commission)
- Its interest expenses have decreased due to reduced debts.
- Solid customer growth in the Utility’s service territory.
- Prospects for rate basing future power resources.
- Higher current dividend yield of 3.8% than its peers and improve balance sheet.
- PSD is not able to totally pass through fuel costs, and hence, is quite sensitive to fuel cost volatility.
- Its depreciation and amortization, and operating and maintenance expenses have increased.
Note: PSD’s Fiscal Year ends December 31.
Revenue
FY Ends: Dec 31 (US$ M) / 1Q06A / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008EElectric Revenue / $467.4 / $530.1 / $527.6 / $413.5 / $1,777.8 / $1,910.4↑ / $1,990.8↑
Gas Revenue / $406.6 / $401.5 / $467.0 / $210.6 / $1,120.1 / $1,194.3 ↑ / $1,259.2↑
Other / $3.7 / $2.7 / $9.3 / $0.7 / $7.9 / $12.0↑ / $10.2 ↑
Total Revenue / $877.7 / $934.2 / $1,003.9 / $635.6 / $2,905.8 / $3,110.3↑ / $3,242.1↑
Y-o-Y Growth / 14.4% / 10.7% / 12.9% / 7.0% / 4.2%
Sequential growth / 79.9% / 7.5% / -36.7%
According to the Zacks Digest average, total revenue in 1Q07 was $1,003.9M, up 14.4% from $877.7M in 1Q06, and7.5% from $934.2M in 4Q06. During the quarter, increasing revenue from all the company’s segments contributed substantially toward the total revenue growth.
The Electric segment contributed $527.6M, the Gas segment contributed $467M, and Corporate and Other contributed $9.3M to total revenue in 1Q07. Electric revenue increased yearly primarily dueto higher sales and increased rates partially offset by rising fuel and purchased power costs. On a yearly basis, gas revenue increased primarily due to higher recovery of purchased gas costs,an increase in customers and increased customer gas usage.
PSE's 1Q07 retail sales volumes for both electricity and natural gas increased 2.9% and 3.9%, respectively, compared to 1Q06, reflecting customer growth and colder average temperatures.
At the end of the quarter, PSE witnessed customer growth of 2.3% and 2.7% in the Electric and Natural Gas segments,respectively,from thecustomer base at the endof March, 2006. As of March 31, 2007, the company provided service to 1,043,300 electric customers and 718,000 natural gas customers in Washington.
Outlook
The Zacks Digest model forecasts total revenue of $3.11B for 2007 and $3.24B for 2008, which reflects a revenue growth of 7.0% in 2007, and 4.2 % in 2008. The estimated compound annual growth rate (CAGR) on realized 2005 revenue is 8.0%.
Management continues to expect customer growth of 2-3% in the future.
Please refer to the Zacks Research Digest spreadsheet on PSD for specific revenue estimates.
Margins
Margins / 1Q06A / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008EEBITDA Margin / 25.0% / 23.0% / 26.3% / 24.4% / 24.4%↓ / 25.1%↓
Operating Margin / 17.4% / 11.9% / 14.6% / 13.0% / 13.7% / 14.5%↔ / 14.5%↑
Net Profit Margin / 8.4% / 6.1% / 7.9% / 4.7% / 5.8% / 6.2%↓ / 6.3%↑
According to the Zacks Digest average, operating income in 1Q07 was $146.8M versus $153.1 M in 1Q06 and $111.0M in 4Q06. Operating income in 1Q07reflects a y-o-y decline of 4.1%.
In the first quarter 2007, PSD’s gas margins improved due to an increase in natural gas volume and a hike in rates, effective from January 2007, but the electric margin deteriorated due to production tax credit benefits which were passed on to customers through reduced rates.
In 1Q07 depreciation and amortization expense was $69.6M compared to $63.9M in 1Q06. The increasedwas primarily due to placing Wild Horse into service and additional utility plant placed in service over the last twelve months.
Interest expenses in 1Q07 increased to $50.0M from $43.5M in 1Q06 due to higher debt associated with Wild Horse and Goldendale.
The Zacks Digest model forecasts operating income of$451.8M for 2007and $468.9 M for 2008, which reflects a y-o-y operating income growth of 13.3% in 2007 and3.8% in 2008.
The Zacks Digest average net income for1Q07 was $79.1M versus $73.6M earned a year ago, reflecting a y-o-y growth of 7.4%.
The Zacks Digest model forecasts net income of $192.9M for 2007, and $205.6M for 2008, which reflects ay-o-y growth of13.8% in 2007and 6.6% in 2008.
Please refer to the Zacks Research Digest spreadsheet on PSD for more details on margin estimates.
Earnings per Share
FY Ends: Dec 31 / 1Q06A / 4Q06A / 1Q07A / 2Q07E / 2006A / 2007E / 2008EZacks Consensus EPS / $0.63 / $0.49 / $0.68 / $0.26 / $1.44 / $1.63 / $1.71
Company Guidance / $1.50-$1.65
Digest High / $0.63 / $0.49 / $0.68 / $0.27 / $1.52 / $1.65 / $1.75
Digest Low / $0.63 / $0.49 / $0.62 / $0.24 / $1.44 / $1.60 / $1.65
Digest Average / $0.63 / $0.49 / $0.67 / $0.26 / $1.49 / $1.62↑ / $1.70↑
Y-o-Y Growth / 5.6% / 13.0% / 4.6% / 8.8% / 5.0%
Sequential growth / 250.0% / 35.7% / -60.9%
According to the Zacks Digest average, EPS from continuing operations in 1Q07was $0.67, compared to $0.63 earned in 1Q06, reflecting a y-o-y growth of 5.6%.
1Q07results were driven by higher retail energy sales volume and rate reliefbut partially offset by under recovery of power costs as well as higher operation and maintenance expenses and depreciation expenses.
Outlook
Management reaffirmed EPS guidance of $1.50-$1.65 per share for 2007.
One firm (D.A. Davidson) expects earnings in 2008 will benefit from a full-year of Goldendale ownership, continuing solid customer growth, and perhaps additional new generating assets, whose costs and investment returns would be recovered through a PCORC or general rate case.
One firm (Zacks Investment Research) believes stable earnings from regulated utility operations, growing electric generating capacity combined with regulated rate hikes, low-cost wind power additions, strong customer base and the sale of InfrastruX will be the foremost driving factors for future earningsgrowth.
One firm (Stifel Nicolaus) lowered the EPS estimate for 2007 from $1.64 to $1.62 whileit maintained the estimate for 2008 at $1.70.
The Digest model forecasts EPS of $1.62 for 2007, and $1.70 for 2008, which represents y-o-y growth of 8.8% in 2007, and 5.0% in 2008. The CAGR on the realized 2005 earnings is 6.1%.
2007 forecasts (6in total) range from $1.60 (J.P.Morgan) to $1.65 (Zacks Investment Research); the avg. is $1.62.
2008 forecast (5 in total) range from $1.65(UnionBankSwitz.) to $1.75 (D.A. Davidson); the avg. is $1.70.
Please refer to “EPS” tab of the Zacks Research Digest spreadsheet on PSD for more extensive EPS figures.
Target Price/Valuation
Of the total brokerage firms following the stock, one gave positive, and fivegave neutral ratings. The average target price is $27.31 (↑from the previous report; 8.3% upside from current price), ranging between $26.00 (Lehman)(3.8% downside from the current price) and $29.00 (D.A. Davidson)(15.1% upside from the current price).
Rating DistributionPositive / 16.7%
Neutral / 83.3%
Negative / 0.0%
Average Target Price / $27.31↑
Digest High / $29.00
Digest Low / $26.00
Number of Analysts with Target Price/Total / 4/6
General risks associated with achieving the target price include volatility of fuel costs, the impact of weather on Puget’s regulated utility sales and regulatory risks.
For more detail on valuations & ratings by individual analysts, refer to the ‘Valuations & Ratings’ tab of the PSD spreadsheet.
Capital Structure/Solvency/Cash Flow/Governance/Other
Capital Expenditure
Though no balance sheet information was released with the earnings announcement, management did affirm the projected capital expenditure. Approximately $2 billion in planned expenditures are slated for the next three years. In 2007, capital expenditure is expected to be $650 million, including $120 million for the Goldendale purchase. To fund the expansion PSD intends to seek an additional $125 million in long-term debt in 2007. In 2008 and 2009, management expects capital expenditures of $625 million and $850 million, respectively, with roughly $300 million of this $1.5 billion for new electric generation and the balance for delivery of existing generation. One firm (Stifel Nicolaus) expects capital expenditure to be$650 million, $625 million, and $850 million for 2007, 2008, and 2009, respectively.
Cash Flow
Cash generated from operations for the quarter ended March 31, 2007 was $228.4 million compared to $318.4 million in 1Q06. The increase was primarily the result of costs incurred in 2006 that did not recur in 2007, collection of the purchased gas receivable and no income taxes during this quarter but partially offset by a decrease in accounts payable.
Debt to capital
PSD expects going forward debt to capital ratio to be within the range of 41% - 42%. PSD also entered into a new $350 millioncredit facility to provide for borrowings, primarily to support the Company's energy price hedgingprogram.
General Rate Case
On January 5, 2007, the Washington Utilities and Transportation Commission (WUTC) issued its order in PSE's consolidated electric and natural gas rate cases. Analysts consider these rate cases an important barometer of WUTC's willingness to address the structural inability of the high-growth utilities in the state to consistently earn authorized returns.
In its order, WUTC authorized PSD a $22.8M electric and $29.5M gas base rate increase premised upon a 10.4% ROE on 44.13% of capital and an 8.4% return on average rate, effective January 13, 2007. The WUTC declined to adopt PSD’s proposed depreciation tracker and natural gas decoupling mechanism; however, it adopted an electric conservation incentive mechanism to be implemented on a pilot basis.
Acquisition of the Goldendale Energy Centre from Calpine Corporation
On April 11, 2007, the Washington Utilities and Transportation Commission (WUTC) allowed deferred accounting treatment for Goldendale’s fixed cost component of operations and maintenance expense, depreciation, taxes and cost of invested capital until the PCORC is decided.
On March 20, 2007, PSE filed a modest increase in its electric rates to recover the costs of the newly acquired power plant in Goldendale, Washington, and higher wholesale power costs. The filing requests the Washington Utilities and Transport Commission to sanction an overall rate increase of 3.7% for PSE’s electric customers, effective from September 1, 2007.
On February 7, 2007, Puget Sound Energy (PSE) received approval to buy a 250 MW power- generating facility in south-central Washington from the federal court administering the CalpineCorporation (CPNLQ) bankruptcy proceedings. The court approved PSE's $120M bid onFebruary 5, 2007 in the bankruptcy auction for the GoldendaleEnergyCenter. Acquisition of the 2 yearold power plant inKlickitatCounty, which can operate at up to 277 MWs with duct firing capacity, is designed to help the utility serve a steadily growing customer base across the Puget Sound region. PSE expects to retain the appropriate staff currently operating Goldendale.
Management is excited about becoming part of the Goldendale community and acquiring a virtually new generating plant at a price that is much less than building it from scratch. Goldendale will help supply PSE’s customer’s rising electricity demands immediately with the most efficient, environmentally advanced gas-fired technology available anywhere.The power plant's turbines, fired by natural gas, employ "combined-cycle" technology that generates electricity using both a natural gas cycle and a steam cycle. This process provides higher operating efficiencies, lower fuel costs, and lower air emissions.
One analyst (D.A. Davidson) believes that the acquisition of this nearly new, 277 MW, gas-fired plant for $433 per kilowatt-hour of capacity is a positive for the utility, securing the company’s power supply resources through 2008.
Dividend
On May 04, 2007, PSD declared quarterly dividends of $0.25 per share on the company's common stock payable on August 15, 2007, to shareholders of record as on July 20, 2007.One firm (Zacks Investment Research) believes, given the high capital spending requirements, PSD will generate negative cash flow going forward, which is likely to limit the ability of the company to maintain the current level of dividend.
Others
On May 08, 2007, PSE announced that EI Solutions will design and construct the Pacific Northwest's largest solar-power generating facility alongside the utility's Wild Horse wind farm in central Washington. At 500 kilowatts, the pilot solar project would roughly double the state's entire solar-powered electricity generation and be four times bigger than any solar facility now in existence in the Northwest. Wild Horse solar will be able to supply about 300 households with electricity. PSE plans to begin construction of the solar project in June and have most of its power-generating panels in operation before the end of 2007.
Potentially Severe Problems
There are none other than those discussed in other sections of this report.
Long-Term Growth
Of the total brokerage firms following PSD, three gave a long-term EPS growth rate, which ranges from 4% (D.A. Davidson) to 7% (Lehman). The Digest average long-term growth rate is 5.0%.
Management expects the Wild Horse and Hopkins Ridge wind farms to produce enough clean, low-cost electricity to service approximately 120,000 households and reduce PSE's overall power-supply costs by roughly $170M over the next 20 years, which will again depend on the future course of natural gas and coal prices.
The BakerRiver project’s current annual license expires on April 30, 2007 and the company already submitted the application to FERC for the license. The proposed settlement includes a set of proposed license articles and, if approved by FERC without material modification, would allow for a new license of 45 years or more. The proposed settlement would require an investment of approximately $360 million over the next 30 years (capital expenditures and operations and maintenance cost) in order to implement the conditions of the new license. PSE will be able to continue to generate low-cost hydropower at its North Cascades facility for several decades if the New Baker River Hydroelectric license is approved by the Federal Energy Regulatory Commission (FERC).
PSD must add on approximately 1,500 average-megawatts of new power supply by 2013 to meet the increasing demand for electricity within its service territory and to maintain the steadily growing customer base.
Potential demand side management (DSM) investments, which are expected to add about 200MW of capacity by 2010, do not qualify for the power cost only rate case (PCORC) but are instead recovered through a separate tariff rider mechanism.
Upcoming Event
The company is scheduled to release its 2Q07 results on July 27, 2007.
The company will pay a quarterly dividend of $0.25 on August 15, 2007.
Individual Analyst Opinions
POSITIVE RATINGS (16.7%)
D.A. Davidson – Buy ($29–target price): 05/07/07 – The firm has maintained a Buy rating and the target price of $29per share, based on the company’s earnings growth outlook and improved valuations in the utility industry. INVESTMENT SUMMARY: The firm states that the chief attractions to the stock remain the current yield of 3.8%, the solid customer growth in the utility’s service territory, improved balance sheet strength, and prospects for rate base approvals for future power resources.
NEUTRAL RATINGS (83.3%)
Zacks Investment Research – Hold ($27.25) – 04/30/07 – The firm is consistent with its Hold rating and the target price of $27.25 per share. The firm believes that overrunning capital expenditure and weak balance sheet will adversely affect the company’s stock price.
J.P. Morgan – Neutral (No target price): 04/26/07 – The firm has maintained a Neutral rating.
Lehman – Equal weight ($26 – target price): 04/27/07 –The firm has maintained an Equal weight rating andtarget priceof$26per share.
Stifel Nicolaus – Hold (No target price): 05/01/07 – The firm has maintained a Hold rating.
UnionBankSwitz. – Neutral ($27 – target price): 04/27/07 – The firm has maintained a Neutral rating with a target price of $27.
Research Associate: Sonia Agarwal
Copy Editor: Ian Madsen, CFA
Content Editor: Jewel Saha