Demonstrating the volatile nature of the stock market this week,Dynegy’s stock price dropped almost 7% yesterday despite ChuckWatson, CEO of Dynegy, announcing that the company expects firstquarter earnings to be 20% higher than industry estimates.

In an interview with The Wall Street Journal, Watson said eachoperating division of the company was operating “on all cylinders.”He said key factors in the performance have been the power tradingdesks in both the U.S. and Europe and synergies from thenow-complete merger with Illinova. He expects earnings of 49cents/share, well above First Call estimates of 41 cents/share.

PaineWebber analyst Ron Barone raised his recurring 2000earnings per share (EPS) estimate from $2.25 to $2.40 as a resultof the news. He also reiterated his attractive rating for thestock, raising the 12-18 month price target from $68/share to$75/share.

The good earnings news is a continuation of a trend from lastyear for the Houston-based company. It reported a net income of$45.1 million in 4Q99, a 56% increase from 4Q98 totals. For theyear, Dynegy reported a 50% increase in recurring net income to$146.1 million. It sold 8.8 Bcf/d of gas during 1999, up 600 MMcf/dfrom 1998, and averaged 9.2 Bcf/d in the fourth quarter.

Despite all of this forward momentum, however, the stock priceslipped drastically from the low $60s area to the high $50s dollararea, as another investment firm, Dain Raucher Wessels (DRW),downgraded Dynegy from strong buy-average to buy-average.

Mark Easterbrook, the analyst at DRW who published the downgradereport, cited the shrinking price spread between liquefiedhydrocarbons and gas liquids (called the frac spread) as the mainreason for the downgrade. Easterbrook said that because of risingnatural gas prices and softening oil prices, the frac spread hasshrunk from $4.20/MMBtu in February to $2.40/MMBtu currently, whichcould seriously affect the earnings of Dynegy’s liquids segment.

The liquids segment, composed of Dynegy’s North Americanmidstream liquids operations, global natural gas liquidstransportation and marketing operations, and North American crudeoil marketing operations was one of the company’s earningshighlights last year. It nearly doubled its earnings beforeinterest and taxes (EBIT) in 1999 to $112.9 million from $57.5million in 1998. EBIT from the liquids segment increased 83% during4Q99 to $41.3 million, compared to normalized EBIT of $22.5 millionin the 1998 quarter.

While cautious of the liquids pricing, Easterbrook only wasmoderately bearish. He raised his 12-18 month price target for thecompany stock as well, from $61/share to $79/share. “We continue tobelieve the stock should do well over the next 12 months, butsuggest investors buy/add to positions on weakness.”

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