S&P Adds 'Accounting Analysis' for Sempra Energy Before Affirming Ratings
In what Standard & Poor's (S&P) says will become more common among the large energy companies, Sempra Energy was the second firm subjected to an accounting analysis to adjust the company's reported financial results to get what S&P considers a more accurate set of financial ratios to adjust or affirm companies' true credit risk. In Sempra's case, the ratings were unchanged, staying at "BBB+" and at the "A" level for its two major utilities.
The S&P analysis is not to imply anything fraudulent being done in a company's accounting methods, it is just a means to keep company comparisons and industry-wide rating assessments on an apples-to-apples basis, said Swami Venkataraman, S&P's San Francisco-based analyst.
"Although Sempra has had a clean financial reporting history and has not been subject to any restatements or investigations regarding accounting irregularities, we made several adjustments to Sempra's reported financial information in order to better reflect the company's financial position and the economic exposure it may face," said Venkataraman. He said the adjustments often "significantly effect" a company's financial ratios that are relied on heavily by S&P to make its evaluation.
S&P also uses the accounting analysis to detect any economic risks a company may be trying to downplay or hide through its accounting practices, but Venkataraman said that was not an issue at all in terms of Sempra. The rating agency's analysis also zeroes in on trading activity, looking for adjustments of reported financial data in terms of (a) energy trading capital adequacy, (b) power purchase agreements, and (c) mark-to-market income vs. cash flow.
Although industry-wide efforts post-Enron have recommended against it, Sempra Energy Trading "remains largely marked-to-market," Venkataraman said, making it important in S&P's estimation -- "beyond understanding the current economic 'unrealized' value or shortfall of the positions -- to adjust Sempra's reported net income to obtain a better reflection of action cash flows from the trading operation.
"Given the prevalence of mark-to-market accounting, portfolio valuation is also an important consideration. Sempra's book of trades is substantially short term in nature, providing for less uncertainty in the prices at which these trades are valued."
Venkataraman also looked at three major lawsuits aimed at Sempra to analyze the accounting related to them and other aspects. He called the exposure to litigation risk "the most important contingent liability facing" Sempra, listing three cases: (1) natural gas Arizona border wholesale price alleged manipulation; (2) alleged misreporting and wash trading by Sempra Energy Trading and others; and (3) electricity class action lawsuits.
The natural gas litigation is "perhaps the most materially significant" and includes so-called Continental Forge anti-trust litigation and two similar anti-trust litigations filed in Nevada by state and utility entities, along with the ongoing California Public Utilities Commission investigation. The Continental Forge case in a California state Superior Court is likely the most significant, Venkataraman said, because of a recent ruling denying Sempra's request for a summary judgment and because it carries potential damages up to $8 billion, which under California law would be automatically trebled.
"No particular reason" dictated that Sempra should be targeted by S&P -- following an accounting analysis of The Williams Cos., Venkataraman said. It is one of what will become a more frequent series, but the rating agency has no intention of doing this for all energy companies.
"We have always said that the accounting of the companies is so complex that it could use some elucidation," he said. "So when we take up that company, we do so for an accounting analysis. We have done Williams, now Sempra, and others will follow as a matter of time."
Even though he acknowledged that the post-Enron accounting reforms have helped with some "standardization" and more transparency among companies in the sector, that "does not mean that we have stopped making adjustments to ratios," Venkataraman said. "We make a lot of adjustments on reported numbers before we calculate ratios. That is what is important."