COC rbc-aug-28-2008.pdf

COMMODITY ASSUMPTION REVISION |COMMENT
AUGUST 28, 2008
Attractive opportunity:Implied gas price in
DYN/MIR/RRI/WMB doesn't make sense
Revising our commodity price forecast, changing
our estimates and updating CNAV/Targets
•Market appears to be over-reacting to the current economic conditions
and fall in natural gas prices, in our view creating an attractive buying
opportunity in particular names, such as DYN, MIR, RRI and WMB.
In addition, we believe AES presents an exceptionally strong buying
opportunity as well, partly due to natural gas price declines, but mostly
due to perceptions of global economic weakness.
•Valuations seem out-of-line based on implied natural gas prices,
especially for DYN/MIR/RRI/WMB.Implied natural gas prices as of
closing prices on 8/26/2008 were $6.00/MMBTU, $5.00, $3.50, and $5.25,
respectively. This has created compelling buying opportunities, in our
opinion.
•Lowering commodity price forecast and revising estimates, CNAVs and
targets.For 2H08, lowered SPOT power price forecast to ~$83/MWh from
~$91/MWh and increased estimated CONTRACTED coal prices to
$70/short-ton (ST) from $50/ST. For 2009, lowered SPOT power price
forecast to ~$77/MWh from ~$101/MWh and increased estimated
CONTRACTED coal prices to $65/ST from $50/ST.
•Introducing 2010 estimates and commodity price forecasts.2010
forecasted SPOT power prices average ~$76/MWh, and CONTRACTED
coal prices average $55/ST.
•Effect on estimates for most companies, including IPPs, are somewhat
muted for various reasons.For IPPs, including RRI and DYN, some
forward selling of power is assumed, particularly in 2H08 and 2009, which
would affect the magnitude of change on estimates. Also, beyond the near
term, we did not change our commodity-price forecast, resulting in little to
no change in our CNAVs or Targets. For utilities, many of the covered
companies have pass-throughs of commodity prices in one form or another
that limit the impact and, in some cases, result in a benefit. Also, other
adjustments were made based on specific company news, which had some
effect on CNAVs and targets.
•Gustav has little effect on our thesis.As powerful as category 3-5
hurricanes are, we believe that Gustav's impact on commodity prices will
not be so significant beyond the next 8-10 weeks as to alter our thesis or
valuation.
•Coal at $150/ST and natural gas at $6/MMBTU are not likely to be
sustainable, i.e., are a physical "impossibility".Economics of power
plants dictate that coal-fired generation will not be pushed on to the margin
because of lower natural gas prices versus coal prices.
•This is not to say that there aren't stocks in our universe that are
undervalued outside of these five names, but we believe that natural gas
price declines have been particularly, and unnecessarily, harsh on DYN,
MIR, RRI, and WMB. However, we would strongly recommend DYN, RRI
and WMB over MIR.
Priced as of prior trading day's market close, EST (unless otherwise noted).
All values in USD unless otherwise noted.
RBC Capital Markets Corp.
Lasan Johong (Analyst)
[phone]; [e-mail]
Emily Christy (Associate)
[phone]; [e-mail]
Ella Faynzilberg (Associate)
[phone]; [e-mail]
For Required Disclosures, please see Page 11.
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Details
Power price assumptions dictated by natural gas
In general, we are lowering our power price assumptions based on lower expected natural gas prices due to expected higher storage
levels from higher than anticipated domestic natural gas production. This conclusion is based on our E&P team's analysis of the
near-term natural gas fundamentals.
Table 1. Commodity price forecast
Source: RBC Capital Markets
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
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Table 2. Estimate and valuation changes*
DYN, MIR, RRI and WMB appear exceptionally poorly valued based on implied natural gas prices
Based on our model and sensitivity analyses, we estimate that the implied natural gas price imbedded in DYN, MIR, RRI and WMB
are $6.00/MMBTU, $5.40, $3.50, and $5.25, respectively, based on closing stock prices as of 08/26/2008. We arrived at the implied
gas price imbedded in the current stock prices by changing our natural gas and power price assumptions until our calculated-NAV
(CNAV) dropped to the current stock prices. In performing this sensitivity analysis, we assumed that our natural gas price assumption
was flat through our modeling horizon of 2035, and that the oil price was also left flat at $60/BBL. Coal prices were assumed to drop
with a drop in natural gas prices, maintaining a spread of $4/MMBTU between coal price and natural gas price.This spread was
maintained unless we could not reach the current stock price. If coal prices had to drop below $24/ST, we left coal prices at
$24/ST, but continued to drop natural gas prices, until our CNAV dropped to the current stock price.As we explain in the next
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
4
paragraph, we think this scenario is highly unlikely, which implies that RRI, in particular, is unreasonably priced.
In all likelihood, coal prices cannot stay at $150/ST while natural gas prices drop to $6/MMBTU
Some investors have asked what would happen if natural gas prices drop to $6/MMBTU while coal prices go to $150/ST. In our view,
this is extremely unlikely to occur, and likely impossible for any significantly lengthy period of time.
Assumptions and clarifications
Before explaining our position, we will make some clarifying statements and lay out our assumptions: We believe that the SPOT price
of coal COULD go to $150/ST while natural gas prices drop to $6/MMBTU, but this is economically irrelevant to generators as this
would NOT be the price at which generators buy coal. We also note that CONTRACTED coal prices are currently estimated to be
significantly lower than SPOT prices, and while smaller quantities of coal for relatively short periods of time (less than or equal to 12
months) can be and have been signed at over $100/ST, this is by no means significantly or grossly impactful to the economics of
generators.
Therefore, we believe that our assumption of $70/ST coal prices through mid-2009 is conservative
Our coal price estimates in our commodity price database are for CONTRACTED coal prices and NOT SPOT prices, which have little
bearing on generator economics.
Let's assume that we do have a sustained $150/ST coal price environment with $6/MMBTU gas price
In a topsy-turvy world, let's assume that we do have SUSTAINED $150/ST coal and $6/MMBTU gas price. Coal price of $150/ST is
roughly equivalent to $6/MMBTU, i.e., parity with natural gas price. Therefore, if this topsy-turvy scenario were to happen,
generators would run natural gas-fired power plants 24/7, as they would be more profitable to run than coal-fired plants, given that
coal-fired plants are less efficient by at least about one-third, have higher operating and environmental costs and emit more CO2.
Under such a scenario, we would be flooded with electricity, which would then lower prices, forcing generators to shut down marginal
plants. In our topsy-turvy world, marginal generators would be coal-fired plants. This would then lead to a surplus of coal, which
would then drastically and dramatically lower coal prices. At the same time, we would see the natural gas price go through the roof as
generators would be consuming natural gas at rates almost double those of what they consume today. As this intricate ballet plays out,
we would quickly achieve a re-balancing of coal prices to natural gas prices.
Given our thesis, coal prices must always remain cheaper than natural gas prices
This isn't always going to occur on a spot basis, but on a contract basis, we believe this should always hold. For example, let's say we
have a $6/MMBTU natural gas price environment, and Generator X needs to sign a new coal supply agreement. If X is being asked to
sign a coal contract at $6/MMBTU, what should X do? Let us first delve into an example where X has available gas-fired generation.
If X can lock in natural gas at $6/MMBTU and forward sell the electricity at the same time, why would X sign the $6/MMBTU coal
contract? It wouldn't. On the other hand, let's say that X does not have in-house gas-fired generation. X would then have to decide
whether to sign a $6/MMBTU coal contract or buy power in the market place. Given that almost all markets have ample natural
gas-fired generation available to X, we think that X would buy the power instead of generating it using coal. Therefore, X's decision
would force excess coal supply into the market. If all generators were to make this choice, we would quickly have a huge excess
supply of coal.
At current transport costs, we estimate that the spread between CONTRACTED coal and natural gas prices ought to be about
$4/MMBTU
Given our thesis, coal prices should remain about $4/MMBTU higher than natural gas prices at current transport costs. Obviously, as
diesel prices decline, we would expect this price differential to also decline. This is how we arrive at the $4/MMBTU difference:
We start with $3/MMBTU coal prices or ~$75/ST. We then add $2/MMBTU for transport, on average, more for coal than natural gas,
based on information gleaned from our coal analyst. Operating costs for a coal plant are estimated to be about $1/MMBTU higher,
including additional environmental costs (before CO2), and we add another $1/MMBTU for the fact that coal plants are at least about
one-third less efficient than a CCGT. This adds up to an approximately $4/MMBTU difference that needs to be maintained between
coal and natural gas.
Valuations and Price Target Impediments
AES
Valuation:We are maintaining our target price of $30, our Top Pick rating, and raising our CNAV to $56 from $53. We believe that
the stock will be pushed towards our target price over the next 12-18 months due to a strong pipeline of growth projects, robust global
economic outlook, and removal of accounting uncertainties. Also, the "decks have been cleared" for AES to resume its growth story.
While the rest of the utility sector may be challenged in 2008 and beyond, we believe that investors will favorably view the value
proposition that AES brings in due course, given the company's multi-year high-growth EPS and cash flow story. Therefore, we
believe that there is significant upside left to the stock. And, given our CNAV, the upside potential could be well above our target
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
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price. We determine our CNAV based on a full discounted cash flow model, while our target price is based on what we believe the
stock performance will be through the end of the year. Specifically, we discount our target to our CNAV because, discount of growth
profile, and investor concern for global risk and credit market turmoil.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 6.89%. Our terminal value multiple of 14.6x is calculated at approximately 25 years from the most recently reported
quarter.
Price Target Impediment:Coordinated or unexpected global recession, bad acquisitions/investments, terrorism, negative headlines,
political/currency risk, commodity prices, weather.
BKH
Valuation:Our calculated net asset value (CNAV) and Target Price for Black Hills are $39 per share. Uncertainty remains around the
future of oil and gas production, as well as the financial terms and earnings associated with the Aquila acquisition.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 8.59%. Our terminal value multiple of 10.5x is calculated at approximately 25 years from the most recently reported
quarter.
Price Target Impediment:Integration of Aquila acquisition, rate regulations may not be favorable, particularly for gas utilities
(post-ILA deal close), higher volatility due to commodity-price exposure from E&P business and other unregulated businesses could
derail move towards target, moderate weather patterns could be damaging, economic turmoil, interest rate risk, tied to capital market
access.
CNP
Valuation:Our target price is $22, which is set at approximately a 12% discount to our calculated net-asset-value (CNAV) of $25 per
share. We determine our CNAV based on a full discounted cash flow model using an average of Free Cash Flow to the Firm and Free
Cash Flow to Equity. We apply a multistage growth rate with a terminal multiple of 15.8x based on a dynamic WACC with an initial
rate of 4.58%. The terminal value is calculated at approximately 25 years from June 2008.
Our 12% discount is predicated on our belief that more visibility is needed for certain long-term projects before the full value of CNP
will be realized by investors. We look for continued development and investments in growth projects, including the remaining pipeline
projects with SE, potential accretive acquisitions, and the steady increase in earnings and dividend that characterizes a strong utility.
Price Target Impediment:Poor Texas economic performance and states in which CNP has operations, moderate weather, unexpected
transmission and distribution outages, poor acquisitions, spiking commodity could have an indirect effect, inability to expand its
electric and natural gas transmission and distribution system.
DUK
Valuation:Our target price and our calculated net-asset-value (CNAV) is $22. We determine our CNAV based on a full discounted
cash flow model using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate
with a terminal multiple of 10.7x based on a dynamic WACC with an initial rate of 8.52%. The terminal value is calculated about 25
years from June 2008.
As a pure-play electric utility with a small fleet of commercial generation, Duke Energy continues to perform as expected with solid
operations, reliable earnings, and steady dividends.
Price Target Impediment:Decline in value of power portfolio, unfavorable regulatory rulings, onerous carbon emission legislation,
cost overruns on capex projects, unwise acquisitions, unforeseen operational setbacks or shutdowns.
DYN
Valuation:Our target and CNAV are both $13 per share. We determine our CNAV based on a full discounted cash flow model using
an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate with a terminal multiple
of 11.6x based on a dynamic WACC with an initial rate of 7.75%. The terminal value is calculated roughly 25 years from the most
recently reported quarter.
We believe that given its minimalist hedging strategy, valuation upside is the strongest with Dynegy among its peers, which can make
it the most enticing investment vehicle in an upward bound commodity fundamental environment. Also, in such a scenario, higher
financial leverage should work to the benefit of DYN investors and not against, which adds more to the upside potential, in our view.
However, timing is key.
Price Target Impediment:Lower than modeled natural gas prices, economic recession, reduced demand, lack of opportunities for
growth, regulatory interference, slow or no deregulation, weather, change of strategy, basis differentials, and M&A.
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
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EIX
Valuation:Our calculated net-asset-value (CNAV) is $69. Our Target Price is $60 and set at a discount to the CNAV due primarily to
general market and economic weakness in the U.S., need for capital to finance growth, need for regulatory approval for projects and
settlement of the lease tax issue with the IRS. We determine our CNAV based on a full discounted cash flow model using an average
of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate with a terminal multiple of about
11.4x based on a dynamic WACC with an initial rate of 7.37%. The terminal value is calculated approximately 25 years forward.
As a regulated electric utility with a solid growth prospects and a favorable regulatory structure, we expect SCE to outperform its
peers. The upside of the Edison Mission Group adds shareholder value while minimizing additional risk. Strong operations, proven
cost controls, solid financial metrics and favorable power fundamentals should result in steady earnings growth for EIX.
Price Target Impediment:Weather, economy, interest rates, environmental concerns, regulatory risk, access to capital markets, IRS
tax settlement, development cost increases, among others.
HTM
Valuation:Our target price and our calculated net-asset-value (CNAV) is $4. We determine our CNAV based on a full discounted
cash flow model using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate
with a terminal multiple of about 9.8x based on a dynamic WACC with an initial rate of 8.79%. The terminal value is calculated
approximately 24 years forward.
As a geothermal operator and developer, HTM should benefit from the considerable federal and state support of renewable energy.
Although a relative start-up operation, projects in the pipeline have secured contract commitments from utilities. As global warming
fears continue, concerns over energy security persist, and carbon legislation becomes a reality, HTM should have power plants coming
online ready to capture the upside from geothermal energy. We believe the upside potential outweighs the risks at this time. We have
modeled conservatively and increased the beta to account for the risk profile.
Price Target Impediment:Contract risks, tax law risks, access to capital markets, construction cost overruns, exploration risks,
commodity prices, operational risk, and regulatory risk.
IDA
Valuation:Our calculated net-asset-value (CNAV) is $38 and we assign a Target Price of $35. We determine our CNAV based on a
full discounted cash flow model using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage
growth rate with a terminal multiple of 11.0x based on a dynamic WACC with an initial rate of 8.10%. The terminal value is
calculated approximately 25 years forward.
As a pure-play electric utility with a significant hydroelectric generation fleet, IDA operates in a heavily regulated environment.
Considering the risk management policies of IDA, the Idaho regulatory structure, solid operations and the above-average population
growth for the service territory, we believe the company continues to perform as expected. Due to hydrology and regulatory risk, we
assign our target price at a discount of ~8% at this time.
Price Target Impediment:Volatile hydrology, unfavorable regulatory decisions, poor growth project selections, operational setbacks,
changes in credit ratings, environmental regulations, cost overruns with the capex projects and weather.
LNG
Valuation:Our target price is $7 and calculated net asset value (CNAV) is $13. We determine CNAV based on a discounted cash flow
model, using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate with a
terminal multiple of about 12.2x based on a dynamic WACC with an initial rate of about 6.78%. The terminal value is calculated
approximately 25 years forward. Our target price discount of $6 to our CNAV is due to uncertainty around the timing of the arrival of
steady cargos and continued investor skepticism about the company's business model.
Cheniere has stable cash flows from its contracts with third parties, and potential upside from its marketing business. However,
without marketing revenues we believe upside is limited. Therefore, much volatility surrounds the stock. In the long-term, we believe
Cheniere should be well positioned to capitalize on the arrival of LNG to North America given its business model.
Given its objective of developing a pure-play LNG company, its business model, and aspirations for cargo deliveries, we believe
Cheniere should be able to provide value to shareholders; however, not without risk. We will continue to assess both risk and
opportunity as the company commences operations of Sabine Pass, and continues its efforts to attract significant cargos.
Price Target Impediment:Chapter 11 filing risk, start-up nature, commodity prices, ability to secure contracts (under favorable terms),
ability to secure steady supply, regulatory risk, weather, access to capital markets, increasing construction costs, and potential
environmental legislation.
MIR
Valuation:Our calculated net asset value (CNAV) for Mirant is $45 per share, but we are setting our target at $33. The discount is due
to uncertainty around the company's risk management practices, hedging strategy and difficulties due to current economic
environment.
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
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On a stand-alone basis, we believe that cash return to shareholders, development of its brownfield projects, and increase in macro
fundamentals are positives, which are offset by its hedging program and lack of a long-term cohesive growth program.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 8.05%. Our terminal value multiple of 11.3x is calculated at approximately 25 years from the most recently reported
quarter.
Price Target Impediment:Potential high cost of capital, decreasing margins from high fuel costs, political risk, high levels of
environmental capital spending, economic recession, risk management complications.
NRG
Valuation:Our target price and our calculated net-asset-value (CNAV) is $45. We determine our CNAV based on a full discounted
cash flow model using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate
with a terminal multiple of 12.8x based on a dynamic WACC with an initial rate of 6.77%. The terminal value is calculated about 25
years from June 2008.
Despite our longer-term reservations on NRG's hedging, PJM capacity payments and greenfield strategies, we believe that the market
currently undervalues the stock and we expect that the quarterly results and certain financial engineering practices justify our valuation
at this time.
Price Target Impediment:Interest rates, leverage, fuel prices, weather, economy, hedging, strong fundamental uplift, and regulatory
risk.
OKE
Valuation:Our calculated net asset value (CNAV) for ONEOK is $56 per share and target price is $55. In the short-term, we expect
strong fundamentals to serve as a tailwind for OKE, particularly at OKS. Also, increasing LP distributions and incentive sharing of GP
distributions should drive growth in the near-term. Over the next five-years, we expect good opportunities, growth, and increasing
dividends, bolstered by increasing demand for natural gas, especially in the generation sector. However, as LNG is introduced into
North America in large quantities, we believe that opportunities and risks in natural gas businesses will present themselves as they do
in any transition period. Due to this uncertainty, we assign our target price of $55 at a discount of 2% to CNAV of $56 at this time.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 6.46%. Our terminal value multiple of 13.1x is calculated at approximately 25 years from the most recently reported
quarter.
Price Target Impediment:Long-term commodity fundamentals and LNG, which may lead to obsolescence of certain business,
near-term commodity price risk, access to growth opportunities or acquisitions for OKS, regulatory interference or short-sightedness,
demographic shift, economic malaise, weather.
ORA
Valuation:Our calculated net-asset-value (CNAV) is $74. Our target price of $65 is set at a discount until more visibility on future
projects is realized, and general market recovery occurs in the U.S. economy. We determine our CNAV based on a full discounted
cash flow model using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate
with a terminal multiple of 9.4x based on a dynamic WACC with an initial rate of 9.86%. The terminal value is calculated at about 25
years forward.
Price Target Impediment:Drilling difficulties for new projects, thermal reservoir problems and execution risk, economy, permitting,
land management, legislative risk and regulatory risk.
PCG
Valuation:Our calculated net asset value (CNAV) for PG&E is $50 per share. Our Target Price of $47 is at a 6% discount to our
CNAV. The discount is based on cost pressures, slowed customer growth and the loss of investor confidence stemming from
disappointing results. Longer term, we believe additional rate-based growth projects will provide additional upside to management's
stated long-term EPS growth rate of 8%, and a rational regulatory regime should continue to support consistent earnings for electric
and gas distribution. We believe PCG value will be fueled by strong rate-based growth, high management credibility, good strategic
vision, solid execution to date, and strong regulatory relationships. In the near-term, there are financial considerations posed by current
state of credit markets. If debt market conditions worsen, earnings could suffer as a result of increased interest expense, and stock
could drop before reaching our target. However, we believe these credit concerns are temporary, and PCG is well positioned given its
investment grade ratings, credit quality and strong regulatory relationships.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 6.02%. Our terminal value multiple of 13.1x is calculated at approximately 25 years from the most recently reported
quarter.
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
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Price Target Impediment:Near-term credit market concerns, poor economic performance in California, regulatory and legislative
risks and impediments, activists (environmental, legislative, regulatory, among others), warmer than normal summer weather or colder
than normal winter weather, unexpected transmission or distribution outages (electricity and natural gas), inability to expand
transmission and distribution system (electricity and natural gas), and volatility in commodity prices.
PNM
Valuation:Our CNAV is $18 per share and our Target Price is $13. We determine our CNAV based on a full discounted cash flow
model using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate with a
terminal multiple of 11.5x based on a dynamic WACC with an initial rate of 7.51%. The terminal value is calculated at approximately
25 years from the last reported quarter.
Our discount is predicated on our belief that investors will not look past the immediate regulatory concerns and towards the potential
growth until the matters are resolved in 1H09. We believe that the company is capable of achieving these objectives with time and
regulatory understanding.
Price Target Impediment:Valuation of PNM assets for JV, plant availability, bad regulatory outcomes, turbulent wholesale markets,
NIMBY issues, and regional economic recession.
RRI
Valuation:Our calculated net-asset-value (CNAV) is $33. We determine our CNAV based on a full discounted cash flow model using
an average of Free Cash Flow to the Firm and Free Cash Flow to Equity. We apply a multistage growth rate with a terminal multiple
of 10.3x based on a dynamic WACC with an initial rate of 9.13%. The terminal value is calculated at about 25 years forward. We set
our target price at $30 – a discount to our CNAV of $33 – based on discount of the forward curve to our commodity price expectations
and general market weakness.
We believe that RRI's approach to achieving wholesale upside, combined with higher pricing in the PJM, tightening supply/demand
fundamentals, and flexibility with investments and growth strategies will continue to drive solid earnings.
Price Target Impediment:Regulatory and political interference, higher than expected decay in retail gross profit due to higher
defection of price-to-beat customers, lower than expected increase in customer conversion to RRI outside of Houston area, economic
recession, particularly in Texas, credit risk, moderate weather, difficult wholesale market environment, worsening electricity market
liquidity.
SRE
Valuation:Our calculated net asset value (CNAV) for Sempra Energy is $76 and target price is $73. The discount exists due to capital
spending requirements, construction in progress, and other capital projects that are in progress or in the planning stages. The company
is also pursuing the acquisition of Energy South. In the longer-term, we believe SRE exhibits strong organic growth potential over the
next four years, fueled by the growing need for risk management products, LNG and generation growth opportunities, utility sector
consolidation and tightening reserve margins.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 7.50%. Our terminal value multiple of 11.2x is calculated at roughly 25-years from the most recent quarter.
Price Target Impediment:California risk (political, regulatory, environmental, legislative and activist)
NIMBY issues, poor infrastructure in California, moderate or very extreme weather, poor acquisition decisions, poor economic
performance in California, cost escalations, closing of Energy South.
SRP
Valuation:Our target price is $14, which is set at an 18% discount to our calculated net-asset-value (CNAV) of about $17 per share.
We determine our CNAV based on a full discounted cash flow model using an average of Free Cash Flow to the Firm and Free Cash
Flow to Equity. We apply a multistage growth rate with a terminal multiple of about 12.5x based on a dynamic WACC with an initial
rate of 6.94%. The terminal value is calculated at about 25 years from June 2008.
Our 18% discount is predicated on our belief that SRP's organic growth potential will outweigh current economic concerns as projects
become more visible, but perhaps not in the next 6 months. Given our strong estimated CAGR over the next five years, our CNAV,
strong FCFAID, good growth prospects, improving balance sheet, strategic options, strong regulatory relationships, conservative
valuation and strong rate-based investment growth, we believe that our valuation is appropriate at this time.
Price Target Impediment:Equity issuances, commodity-price volatility, weather, economy, interest rates, access to capital markets,
credit rating initiatives and regulatory risk among others.
SUG
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
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Valuation:Our calculated net asset value (CNAV) for Southern Union is $30 per share; we have also set our target price at $30. In the
longer term, we believe SUG's strategic objective is to be well positioned for the arrival of LNG to North America, and expand
delivery capability into the Midwest, Florida and the Northeast. While we do not feel that forming an MLP to run the gathering and
processing business is optimal, we do believe the MLP could create shareholder value, and that SUG should continue producing
steady earnings.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 7.20%. Our terminal value multiple of 11.9x is calculated at approximately 25 years from the most recently reported
quarter.
Price Target Impediment:Commodity price volatility, dependent on volatility of E&P business, changing fundamentals in natural gas,
moderate or very extreme weather, poor acquisition decisions, economic recession, sub-optimal reasons for formation of MLP.
TE
Valuation:Our calculated net-asset-value (CNAV) and target price is $22. We determine our CNAV based on a full discounted cash
flow model using an average of Free Cash Flow to the Firm and Free Cash Flow to Equity after the sale of Transport. We apply a
multistage growth rate with a terminal multiple of about 12.3x based on a dynamic WACC with an initial rate of 6.94%. The terminal
value is calculated approximately 25 years forward.
As a regulated electric utility TE should produce consistent earnings and steady dividends for years to come. Although the coal
business and Guatemala investment steals managerial attention from the growing utility, the company's recent sale of its transport
business reduced the risk profile for the company. This sale combined with the company's accelerated debt repayment plan
strengthened the balance sheet and led to upgrades from credit agencies in 2007.
Price Target Impediment:Commodity prices, weather, regulatory risk, access to capital markets, construction cost overruns, FL
economy, and potential environmental legislation.
WMB
Valuation:Our calculated net asset value (CNAV) for Williams is $50 per share and target price is $45. We believe that E&P will
drive growth, and Williams should benefit from favorable commodity prices. Pipeline operations continue to experience a boost from
higher rates, as are NGL revenues that we believe are also going to fare well due to high margins. We think these fundamentals should
be favorable to WMB for some time, and, therefore, assign our target price of $45 at a 10% discount to our CNAV of $50, which
denotes longer-term value.
We determine our CNAV using a full discounted cash flow model assuming a multi-stage growth profile, using a dynamic WACC
initially valued at 8.37%. Our terminal value multiple of 10.9x is calculated at approximately 25 years from the most recently reported
quarter.
Price Target Impediment:Reduction in E&P production and reserves, lack of takeaway capacity from the Rocky Mountains,
increasing costs, lower-than-expected gathering volumes, commodity price risk, decline in throughput on the company's pipelines,
weather and economic factors.
Companies Mentioned
AES ($15.43, Top Pick, Above Average Risk)
BKH ($34.32, Sector Perform, Average Risk)
CNP ($15.84, Outperform, Average Risk)
DUK ($17.73, Sector Perform, Average Risk)
DYN ($6.04, Outperform, Above Average Risk)
EIX ($46.48, Outperform, Average Risk)
HTM ($1.94, Outperform, Speculative Risk)
IDA ($30.02, Sector Perform, Above Average Risk)
LNG ($3.66, Sector Perform, Speculative Risk)
MIR ($30.14, Sector Perform, Above Average Risk)
NRG ($38.88, Sector Perform, Average Risk)
OKE ($43.63, Sector Perform, Average Risk)
ORA ($50.07, Outperform, Above Average Risk)
PCG ($41.57, Sector Perform, Average Risk)
PNM ($11.53, Sector Perform, Above Average Risk)
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
10
RRI ($16.81, Outperform, Above Average Risk)
SRE ($58.08, Outperform, Average Risk)
SRP ($11.39, Outperform, Average Risk)
SUG ($26.00, Sector Perform, Average Risk)
TE ($17.51, Sector Perform, Above Average Risk)
WMB ($31.93, Outperform, Above Average Risk)
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
11
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Distribution of Ratings/IB Services
RBC Capital Markets
Investment Banking
Serv./Past 12 Mos.
Rating Count Percent Count Percent
BUY[TP/O] 564 48.79 194 34.40
HOLD[SP] 511 44.20 120 23.48
SELL[U] 81 7.01 17 20.99
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Important Disclosures
Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008
12
The analyst(s) responsible for preparing this research report received compensation that is based upon various factors,
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Attractive opportunity:Implied gas price in DYN/MIR/RRI/WMB doesn't make senseAugust 28, 2008