Significant balance sheet challenges kept at least one Wall Street rating agency restrained in its outlook following Bellevue, WA-based Puget Energy’s report of record second quarter earnings last Thursday. Puget’s second quarter results showed $29.4 million, or 34 cents/common share, in net income, compared to second quarter results last year of $17.4 million, or 20 cents/share.

Puget, which is the parent of combination natural gas-electric utility, Puget Sound Energy, said that the second quarter results exceeded analysts’ earlier expectations for earnings in the 20 to 23 cents/share range. However, because of delays in getting electric utility rate coverage of last year’s high wholesale power costs, the 12-month-to-date results were down considerably over the same period last year.

Just before the earnings announcement last Thursday, Puget Energy announced its tenth nonutility acquisition in the utility engineering/construction sector nationally with the purchase for an undisclosed price of Flowers Construction in Hillsboro, TX by Puget’s InfrastruX Group, Inc., a nonutility subsidiary that contributed 3 cents/share of the second quarter profits. In response to a specific question during an analysts’ conference call Friday, Puget executives noted that the company has no plans to pursue any utility merger/acquisition activity.

Standard & Poor’s quickly affirmed Puget Energy’s below-investment-grade triple B-minus (BBB-) credit rating, removing it from its CreditWatch status, but sticking with a negative outlook, mostly because its nonutility activities could work against full restoration of the recently cash-strained utility operation.

“The negative outlook reflects the fact that current financial ratios are weak for the rating and a concern that Puget and (its) utility might not be able to achieve current projects, which indicate that both entities should achieve financial targets consistent with the rating by 2004 and 2005,” said Kathryn Mock, an S&P analyst in its San Francisco office. “Although the settlement agreement provides tools, such as power cost adjustment and required annual equity targets that should enable the utility and Puget Energy to achieve its projections, additional investment in the unregulated subsidiary, InfrastruX, could hinder the financial recovery of Puget Energy.”

Puget Energy’s senior executives on a conference call Friday talked bullishly about the recent rate settlement with state of Washington regulators, their desire to build or buy (plants or output) new utility-owned generation, and raise the company’s equity portion systematically to meet terms of the detailed, four-year rate-making settlement that became effective July 1.

“”I am very, very pleased with our progress,” said Stephen Reynolds, Puget Energy’s CEO. “Our strategy is simple. We call it ‘Boring Is Beautiful’. And we’ll work diligently and ethically to implement it.”

Reynolds and other senior officials noted that the reduction in the company’s exposure to wholesale energy price volatility limits it over the next four years to about 30 cents/share, or 7.5 cents/share/year, compared to an erosion in earnings from last year’s wholesale energy price spikes that totaled about $1/share for the holding company. S&P noted that the power cost rate adjustment limits the utility’s exposure to $40 million over the next four years, along with 1% of any costs exceeding the $40 million level.

“During the next three years, the power cost adjustment should enable Puget to recover any significant variable power costs while it rebuilds its equity position and limits future debt issuance,” Mock said in her assessment of Puget’s current credit ratings.

As an offshoot of the broad-based regulatory settlement, Puget agreed to look a new investment in utility-controlled generation, and Reynolds signaled that the company is about to embark on that course. “We’ll look at all alternative — build, buy, and other options — anything in the right place with the right terms and conditions,” said Reynolds, noting that also part of the settlement is a “streamlined rate case processing” procedure to allow for quick regulatory rulings on the utility’s attempt to add to its power supply resources.

Mock noted that Puget’s rate settlement “reflects an improving relationship between the company and regulators.”

On a 12-month period ended June 30, 2002, Puget’s positive quarterly results are reversed because the longer period includes nine months from mid-year 2001 through the first quarter when Puget’s utility was under-recovering its drastically increased power costs during last year’s wholesale power supply/price crunch that struck throughout the western states. For the 12 months through June 30 this year, earnings were $64.8 million, or 74 cents/share, compared to $171.3 million, or $1.99/share, for the 12 months ended June 30 last year.

In the second quarter, the Puget Sound utility received a $25 million interim electric rate boost, allowing the utility to recover its increased power supply costs, according to Puget Energy’s Reynolds, who called it a “very positive step” toward regaining the company’s financial strength. “I’m happy to report the company is delivering on the plans that we outlined in March of this year.

“Going forward, on July 1, electric customer rates increased 4.6%, following the state regulatory approval of a settlement agreement in Puget Sound Energy’s electric rate case,” he said, noting that the agreement includes a new power-cost adjustment mechanism aimed at lessening the problem of wholesale price spikes in the future. The successful conclusion of the electric rate settlement, and the expected late-summer settlement of our natural gas rate increase, puts us on track to deliver stable utility earnings and grow the company.”

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