COC keybanc-sept-30-2010.pdf

1
ACTION STATEMENT
We are upgrading shares of IDACORP, Inc. (IDA-NYSE) after looking at certain
aspects of the story with fresh eyes. In particular, there are nuances surrounding tax
methodologies that we do not feel are fully reflected in the shares. Specifically, the
benefit of two deductions will flow to the equity balance of the Idaho utility. Under
IDA's existing settlement, the Company essentially has an earnings floor driven by
the ability to amortize deferred tax credits to achieve a 9.5% ROE. Further, given the
cash benefit of a recent deduction, and expectation of a larger one, we believe IDA
may have lesser equity needs than we previously expected. We further believe the
cash benefits could allow management to engage in more constructive discussion
around the potential for raising the dividend.
KEY INVESTMENT POINTS
We are updating our estimates to account for an expected higher equity balance at
Idaho Power (the regulated utility) resulting from two tax methodology changes.
Recall Idaho Power is permitted an Idaho jurisdictional floor ROE of 9.5% under its
Idaho settlement.
Aside from driving higher net income, we expect the cash flow benefits from the tax
items will reduce the need for external equity, driving EPS higher. In our view, the
improved cash flow could also impact the way management thinks about a potential
dividend increase.
We have therefore raised our 2011E from $2.80 to $3.05 per share. Well above the
$2.88 consensus estimate, our estimate is now the high on the Street.
In our view, the benefit of the two tax items is not fully appreciated in the consensus
view, as Idaho regulation permits flow through of taxes as opposed to deferred
treatment.
Given the improved outlook, we are raising our rating to BUY from HOLD and
establishing a $38.50 price target. We believe shares offer a 12-month total return
potential of nearly 11%.
VALUATION
Based upon our revised 2011 estimate, shares of IDA sell at a P/E multiple of 11.8x,
representing a 7% discount to the group average multiple of 12.6x. We believe
shares warrant an average valuation given stability of earnings under the settlement
and attractive investment opportunities. Our $38.50 price target represents a P/E
ratio of 12.6x, consistent with the group average.
RISKS
We believe the primary risks that could impede IDA shares from achieving our price
target are well below normal precipitation levels for a few years, worsening demand
trends and high inflation, which could exert earnings pressure even with IDA's current
constructive settlement, given IDA's inability to file a near-term general rate case.
September 30, 2010 KeyBanc
ENERGY: Utilities Capital Markets
Estimates Change / Rating Change
IDACORP, Inc.:
IDA: Upgrading to BUY as Tax Items Drive Equity Balance
KeyBanc Capital Markets Inc.
Member NYSE/FINRA/SIPC
Paul T. Ridzon:[phone] —[e-mail]
Timothy Yee:[phone] —[e-mail]
Rating BUY
Price $35.92
12-Mo. Price Target $38.50
Dividend $1.20
Yield 3.3%
52-Wk. Range $28-$37
Trading Volume 248
Market Cap. (mm)$1,720.6
Shares Out. (mm)47.90
Book Value/Share $29.69
Fiscal Year End December
2011E $3.05
2010E $2.85
2009A $2.58
2011 P/E 11.8x
2010 P/E 12.6x
First Call 2011E $2.88
First Call 2010E $2.76
Next Quarter September
Estimate $1.20
Vs.$1.16
First Call Estimate $1.25
FOR IMPORTANT DISCLOSURES AND CERTIFICATIONS, PLEASE REFER TO PAGES 4 - 5 OF THIS NOTE.
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DISCUSSION OF TAX ITEMS
As discussed, we look for IDA to benefit from two tax items. The first is the methodology change of treating repairs as expenses as
opposed to previous capitalization treatment. This produced a 2Q benefit of $25.2 million (net of a reserve of $10.9 million) for the
tax years 1999-2009. Additionally, IDA booked a $3.6 million benefit for 1H10, as the new treatment has ongoing benefits.
IDA also indicated it was in discussions with the IRS concerning issues around uniform capitalization (UCAP) rules. This aspect of
tax law deals with the capitalization of direct and indirect expenses in the construction of an asset, and how these costs are to be
included in the tax basis of the asset. IDA has indicated that while the issue was still being finalized, it expected that application
would result in a tax benefit at least as big as the gross amount ($25.2 million plus the $10.9 million reserve) of the repairs deduction
booked in 2Q10. In our view, IDA management tends to be very conservative, and we therefore assume that this deduction could be
on the order of magnitude of $60 million-$70 million. Further, because we understand that IDA is being directed to use this tax
treatment by the IRS, we would expect minimal reserves to be booked against this amount.
IMPLICATIONS OF TAX METHOD CHANGES
These two tax items are important given that the Idaho commission specifies flow-through tax accounting. Under this treatment, the
refund will flow to the equity balance on the balance sheet without an offsetting deferred tax entry. The result is that the equity
balance could be $85 million-$95 million greater than it would be absent these 2010 tax events. Recall that under IDA's settlement,
the Company is allowed to earn a 9.5% ROE on utility book equity, utilizing Accumulated Deferred Investment Tax Credits if
necessary.
Additionally, given the cash flow benefits of these tax refunds and lower taxes going forward, we now expect IDA will likely be able
to fund the equity capitalization of its 300 MW Langley Gulch power plant construction project without meaningful external equity
beyond its DRIP. Langley Gulch is expected to cost $427 million and be in service late 2012.
Company NoteSeptember 30, 2010
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TIMING OF TAX ACTIVITY COULD HAVE MEANINGFUL IMPLICATIONS
We believe the timing of the UCAP deduction could have a large impact on earnings. If the deduction is taken in 2010, we believe it
could push earnings above the 9.5-10.5% earnings deadband outlined in IDA's rate settlement. Above this level, earnings would be
shared 50%/50% with ratepayers. Any portion allocated to ratepayers is not expected to be included in utility equity. However, if
uncertainty around the calculation of the deduction were to push the actual booking into 2011, we expect year-end 2011 utility equity
would be larger (by the amount of the customer credit). We further note the potential for a portion of the deduction to be booked in
2010, inasmuch as it related to portions of the accounting that are characterized by greater clarity. As IDA works with the Service
and its auditors, additional deductions could be booked in 2011. We expect the timing to be driven by auditors' views of the specific
facts and circumstances.
We have revised our 2011 estimate upward from $2.80 to $3.05 per share. This higher estimate is driven by two items. Firstly, the
higher equity balance will drive increased earnings to achieve the 9.5% ROE floor stipulated in IDA's rate settlement. Secondly, we
are no longer assuming an equity raise in our assumptions. We are also raising our 2010 estimate to $2.85 from $2.75 to reflect
higher equity. If the UCAP does fully occur in 2010, the GAAP number could be very large. We acknowledge that differentiating
between GAAP and ongoing earnings could be challenging. For our purposes, we use the earnings power based upon earning a
9.5% ROE in the Idaho jurisdiction. We anticipate 2010 is likely to have more moving pieces than 2010.
IDAHO SETTLEMENT DISCUSSION
We view IDA's approved Idaho settlement favorably. Under the terms of this stipulation, IDA has meaningful downside earnings
protection through the ability to accelerate $45 million of its $70 million bank of accumulated deferred income tax credits (ADITC). If
necessary, IDA may accelerate the amortization of these credits if the Company is going to earn a return on equity (ROE) below
9.5%. The ROE calculation is based upon the year-end equity balance, which we believe is favorable during a period of elevated
capital expenditures in that it alleviates regulatory lag.
In 2009, IDA could have accelerated up to $15 million of these credits, but this was not necessary. In each of the subsequent years
(2010 and 2011), up to $25 million may be utilized. The total available in the three years covered by the settlement is $45 million. In
our view, utilizing the entire $45 million would only be necessary under a scenario of very poor hydro conditions and weak demand.
As part of the settlement, IDA has agreed to split evenly with ratepayers any earnings in excess of an earned ROE of 10.5%.
Approximately 95% of IDA's regulated rate base is within the state of Idaho, and is therefore covered by the stipulation. We believe
this offers substantial downside earnings protection. IDA has agreed not to file for new rates to be effective before January 1, 2012.
EPS (Net)Summary
2009A %CHG 2010E %CHG 2011E %CHG
1Q $0.44 -8.3%$0.34A -22.7%----
2Q $0.49 40.0%$0.82A 67.3%----
3Q $1.16 1.8%$1.20 3.4%----
4Q $0.49 88.5%--------
YEAR $2.58 15.7%$2.85 10.5%$3.05 7.0%
Source: KeyBanc Capital Markets Inc. estimates
Note 1: 2010 Q2: $0.82 reported includes $0.53 benefit from tax accounting method change
for repair-related expenses and $0.09 loss on reversal of 1Q10 ADITC amortization.
Company NoteSeptember 30, 2010
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KeyBanc Capital Markets Inc.Disclosures and Certifications
IDACORP, Inc. - IDA
IDACORP, Inc. is an investment banking client of ours.
We have received compensation for investment banking services from IDACORP, Inc. during the past 12 months
We expect to receive or intend to seek compensation for investment banking services from IDACORP, Inc. within the next
three months.
During the past 12 months, IDACORP, Inc. has been a client of the firm or its affiliates for non-securities related services.
Reg A/C Certification
The research analyst(s) responsible for the preparation of this research report certifies that:(1) all the views expressed in
this research report accurately reflect the research analyst's personal views about any and all of the subject securities or
issuers; and (2) no part of the research analyst's compensation was, is, or will be directly or indirectly related to the
specific recommendations or views expressed by the research analyst(s) in this research report.
Three-Year Rating and Price Target History
Rating Disclosures
Distribution of Ratings/IB Services Firmwide and by Sector
KeyBanc Capital Markets
IB Serv/Past 12 Mos.
Rating Count Percent Count Percent
BUY [BUY]193 47.80 44 22.80
HOLD [HOLD]205 50.70 54 26.34
SELL [UND]6 1.50 1 16.67
ENERGY
IB Serv/Past 12 Mos.
Rating Count Percent Count Percent
BUY [BUY]24 41.40 12 50.00
HOLD [HOLD]34 58.60 22 64.71
SELL [UND]0 0.00 0 0.00
Company NoteSeptember 30, 2010
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Rating System
BUY - The security is expected to outperform the market over the next six to 12 months; investors should consider adding
the security to their holdings opportunistically, subject to their overall diversification requirements.
HOLD - The security is expected to perform in line with general market indices over the next six to 12 months; no buy or sell
action is recommended at this time.
UNDERWEIGHT - The security is expected to underperform the market over the next six to 12 months; investors should
reduce their holdings opportunistically.
The information contained in this report is based on sources considered to be reliable but is not represented to be
complete and its accuracy is not guaranteed. The opinions expressed reflect the judgment of the author as of the date of
publication and are subject to change without notice. This report does not constitute an offer to sell or a solicitation of an
offer to buy any securities. Our company policy prohibits research analysts and members of their families from owning
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recommendations, ratings from investor clients, competitive factors and overall Firm revenues, which include revenues
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Investors should assume that we are seeking or will seek investment banking or other business relationships with the
company described in this report.
Company NoteSeptember 30, 2010