Dynegy Inc.’s management team last week attempted to convince investors that it was focused on future performance, but the news was overshadowed by a 76% reduction in 2004 earnings’ estimates and a projected net loss in 2005.
Shares slipped as much as 14% following the announcement Wednesday, and a downgrade to “neutral” from “buy” by Calyon Securities on Thursday sent the stock lower again. After beginning the week in the $5.60 range, Dynegy’s shares were hovering around $4.40 at midday Friday.
The Houston-based company surprised analysts and the marketplace last week during a scheduled investor conference by announcing it would cut its 2004 earnings forecast to between $2-22 million (1-6 cents/share) from an estimate issued just two months ago of $75-95 million (20-25 cents). The reduction was precipitated by a $73 million charge that the company will take in 4Q to reflect a $117.5 million lump sum payment to a unit of Constellation Energy Group Inc. to take over a tolling agreement with LSP-Kendall Energy LLC for the next four years (see Power Market Today, Nov. 19).
Dynegy also set its guidance in 2005 at a net loss of $375-391 million for several reasons, including a $220 million expense to settle another tolling agreement in 1Q2005 and an $80 million decline in margins expected to roll off of a power contract with the California Department of Water Resources.
Chris Ellinghaus, an analyst with Williams Capital Group, said that by highlighting its long-term outlook, Dynegy “didn’t provide a whole lot of support for today’s stock price.” He said, “Unfortunately, they’re not making a strong financial case for the moment. The long-term prospects are there, but today’s prospects don’t look as good as they did yesterday.”
Ellinghaus suggested that some of the stock losses may have been avoided if the company had not provided guidance on the basis of generally accepted accounting principles (GAAP) instead of on an adjusted basis. GAAP includes non-recurring items. Under an adjusted basis, Ellinghaus had forecast Dynegy’s 2004 earnings at 5 cents/share, which isn’t changed by the $73 million tolling charges.
The size of the estimated losses is surprising, he noted. Ellinghaus had expected Dynegy to lose about 10 cents/share in 2005, but said it now could be closer to 34 cents/share. Other non-recurring items could send the losses higher, he said. Because of the complexity of the information provided by Dynegy, Ellinghaus said investors needed to”sit down and absorb” what they heard before valuing the stock.
In a research note, Calyon analyst Craig Shere said Dynegy’s news “will limit near-term upside potential.” Calyon cut its 12-month target price to $5 from $6.25.
During the conference last Wednesday, Dynegy CEO Bruce Williamson said that the company was getting back to business by paying down or deferring debt and eliminating the costly tolling agreements. By the end of 2004, Dynegy will reduce its debt maturing within five years to $480 million from $5.2 billion two years ago and will have reduced its long-term capacity payments for tolling contracts to $2.2 billion from $4.4 billion in late 2002.
As he fielded questions on the possible sale of more assets, Williamson said the company continues to be guided by the principles put in place since it began its self restructuring in 2003: to accept responsibility, to restore credibility and to continue to work for all of the company’s investors in the capital structure.
“In the last two years, we had to get equal with each other,” Williamson explained. “We haven’t just been working on refinancing, although that may be what many believe.”
CFO Nick Caruso added, “We had a lot of issues that we had to deal with, and we had to deal with them firmly and expeditiously.” The restructuring is completed, he said, and most of the claims and investigations against the company have been settled. “We have undertaken initiatives to simplify this company,” said Caruso. Now, Dynegy has a “much, much more simplified capital structure that gives us the ability to do a lot of different types of financial things.” Since 2002, Dynegy has reduced its debt by $3.3 billion, or 37%, and maintained “strong” liquidity, he said.
Still, Dynegy will be riding a bumpy path at least through 2005. In 2002 and 2003, Dynegy had combined losses of more than $3 billion, which resulted from Enron Corp.’s bankruptcy and the implosion of the energy merchant sector. If the tolling contracts and debt retirement costs are excluded, 2005 earnings before interest, taxes, depreciation and amortization will be $450-475 million, Caruso said. Dynegy expects to earn $345 million from its power generation business and $290 million from its midstream operations.
Dynegy’s businesses overall are performing well, said Williamson. He said the midstream business is strong, and acknowledged that he has been approached by some peers on whether he would sell any of the assets.
“There’s a growing scarcity of significant midstream assets and MLP (master limited partnership) buyers have a continued demand for assets.” Williamson said Dynegy is not interested in selling anything except the tolling agreements.
Alec Dreyer, vice president of the power generation unit, said recovery in the marketplace has taken time, but “we believe capacity markets will develop and mature,” and said he expects a full market recovery within five to six years. “We believe you can build a new combined-cycle plant and actually earn a return on capital. And we finally believe the regional markets will be successful. Most importantly, the attributes all must fit together.”
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