Continuing to take the low road on certain energy companies, Salomon Smith Barney (SSB) Friday knocked the props out from under American Electric Power (AEP) and El Paso Corp., removing the “outperform” label and dropping them back “in-line” with the rest of the gas and electric utility sector.

SSB lowered its share price targets to $16 for AEP and $4 for El Paso. The two companies already had been rated “high risk” and “speculative” by SSB and now are both “speculative.” The investment house also dropped Duke Energy (already in-line) to “speculative.”

SSB analyst Raymond Niles, chief author of the report issued Friday said, “we were and continue to be bearish on these names.” They had been the best of the lot, the analyst said, “but we think risk levels across the industry are too high now to rate any stocks higher than in-line.” Besides company-specific issues, the industry fundamentals continue to weigh heavily. “In our opinion, there are few, if any, catalysts that would help to stabilize the industry in the near- to mid-term.”

The three companies are part of a group of 23 diversified gas and electric companies on the Standard & Poor’s Multi-Utilities and Unregulated Power Index, which SSB has labeled “underweight.”

For El Paso, the big issue is the FERC administrative law judge decision and the likelihood that it will be several months before the full Commission makes its pronouncement. “In this environment, we believe investors will continue to assume the worst and anticipate numerous lawsuits stemming from this situation.” In addition, Oscar Wyatt, who sold the Coastal Corp. to El Paso and is a major shareholder, “apparently made it his crusade to oust company management, again an issue lacking a clear near-term resolution.” SSB also sees limited growth prospects in the energy trading business, and is concerned about the uncertainty surrounding the resolution of the company’s Limestone (Project Electron) structure, which come due in March 2003.

SSB sees AEP’s annual $2.40 per share dividend endangered, and questions whether unwinding its trading book and scaling back trading “may uncover potential exposures or reduced valuations.” Based on its reading of AEP’s third and fourth quarter earnings the analyst group lowered its 2002 guidance from $2.80 to $2.70. The current dividend level would add up to an 86% payout — “above our comfort level of approximately 70-80%.” SSB sees AEP having to take additional steps to reduce debt besides cutting back $1 billion per year in growth capital.

Duke’s rating went from “high risk” to “speculative” mostly based on the “negative headline risk” suffered by any company in the industry. Duke “may well incur the operational and regulatory scrutiny that we have seen plague so many other members of the industry, which has led to charges of price manipulation,” but “we do not expect that Duke took part in these actions,” SSB said. The analyst also is beginning to look at risk to the company’s dividend. “In our opinion, the highly variable cash flows from merchant operations inherently cannot support a meaningful dividend.”

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