It’s back to the future for El Paso Corp., company executives said Monday, with the focus beyond 2006 returning exclusively to natural gas, both pipelines and exploration and production (E&P). All of its U.S. power assets, all of its oil refining and eventually, all telecommunications businesses will be sold, and others will be streamlined, including marketing and physical trading and midstream.
Among other things, nearly all of El Paso’s non-U.S. properties will be sold, with the exception of those in Brazil, to concentrate on domestic opportunities mainly in Texas, the Rocky Mountains and the deep shelf of the Gulf of Mexico. The company also plans a bigger emphasis on coalbed methane (CBM) operations to stabilize its production profile and help lower costs.
During a two-hour conference call with investors and analysts, El Paso CEO Doug Foshee and his executive team outlined their long-range plans. Along with a goal to cut debt to $15 billion by the end of 2005, “this plan will give us clarity of purpose,” Foshee said. Management listened to the concerns of its shareholders, he said, and wanted to answer the question most asked: what is El Paso’s purpose?
In response, said Foshee, the company is going back to basics. “Our purpose is to provide natural gas in a safe, dependable manner. Everything we’re going to be in the next five years fits into that.” Going forward, El Paso will be organized around regulated and unregulated businesses.
Regulated businesses will consist of its three pipeline divisions — southern, western and eastern — which will include joint ventures and operations with Mexico. Unregulated businesses will consist of production and processing, the Brazilian integrated business, and initially, Asian power operations; domestic, European and Central American power operations, marketing and trading; joint ownership in Enterprise Products LP (see story), El Paso Global Networks; telecommunications; and discontinued operations. But, all of anticipated asset sales outside the core gas business are expected to be completed by 2006.
Long-term, the plan will reduce El Paso’s total debt, net to cash, about $15 billion by the end of 2005. At the end of the third quarter 2003, El Paso’s debt stood at $22 billion. Debt reduction will come from sales already announced and those anticipated, which will bring between $3.3-$3.9 billion; selling restructured power contracts; recovering $500-$900 million in working capital; covering 9% equity security units ($575 million); as well as free cash flow generation and other actions taken in the fourth quarter of 2003.
If all falls into place, El Paso’s financial targets for 2006 include the following: $500 million to $725 million of net income, or earnings per share of $0.75 to $1.10; cash flow from operations of $1.9 billion to $2.2 billion; free cash flow after capital expenditures and dividends of $200 million to $400 million; annual growth and maintenance capital of $1.6 billion to $1.7 billion; and $150 million in cost reductions in addition to the $445 million already identified.
Operating cash flow generation, $2.1 billion of available cash and credit lines (as of Nov. 30) and planned asset sales will give the company “significant” liquidity through 2005. However, it also identified potential sources of earnings volatility over the next several years: the impact of natural gas prices, discount rates used in its trading and restructured power contract portfolios, movement of the Euro relative to the dollar, the impact of commodity prices on its trading portfolio and possible changes in natural gas and liquids reserve estimates, which could cause ceiling test charges.
Results won’t happen overnight, said Foshee. “But our goals are attainable. We’ve got to finish our divestiture plan. We got a heck of a good start on that this morning” (because of GulfTerra’s merger with Enterprise Products). “A lot of that is very near term. We have to get cost reductions, and they are totally within our control. We have to turn around the production company. There are some very near-term things we can do and we are going to get after them today.”
Foshee said El Paso “absolutely can deliver the results by 2006. We will focus on where we will be, and have milestones between now and 2006 so you can measure our progress.”
Along with its operations restructuring, El Paso also has set up a new performance management system to link compensation with metrics, “tied directly to shareholder value created by the business units, as well as total shareholder return relative to its peer companies.” The company noted that with 10 of 12 independent directors on its board, separate chairman and CEO positions, no staggered board and no poison pill, “El Paso will demonstrate its commitment to strong corporate governance.” The company added five new directors this year, all with backgrounds in production.
“We are creating a ‘fit-for-purpose’ organization designed to provide natural gas in a safe, efficient, dependable manner,” said Foshee. “We have a great group of employees and directors, and I’m confident we can deliver on the commitments in the plan.”
In response to the restructuring, Standard & Poor’s Ratings Services lowered its corporate credit rating to “B” from “B+.” Even with its “many credit-friendly elements…considerable risks remain as the company tries to execute the plan,” said analyst Todd Shipman. “If the company is successful, Standard & Poor’s believes it could provide a foundation for stabilizing and eventually improving El Paso’s credit profile,” he continued. “The heightened risks during the transition period necessitate a lower credit rating and a continuation of the negative outlook until some progress on the plan is accomplished.”
Shipman said that “the greatest task ahead for El Paso management is the transformation of its E&P operations, which today are characterized by an extensive geographic scope, rapidly depleting production centered in mature basins and intense capital needs to maintain and increase production levels.”
Moody’s Investors Service, which confirmed current ratings but dropped its outlook on the company to “negative,” said El Paso’s “turnaround plan” offers “only a modest near-term change from its pre-existing initiatives and limited immediate change from factors we considered in changing its outlook to negative last month. The negative outlook reflects the numerous challenges and extended time frame in executing this plan and our assessment that there will not be a material improvement in the company’s credit profile in the immediate future. In the meantime, EP continues to face sinking natural gas production, falling but still heavy spending needs, and exposure to volatile natural gas prices. ”
Moody’s analysts were encouraged with the Enterprise Products merger, which “together with a proven turnaround of EP’s E&P business, are keys to strengthening EP’s credit profile over the next year. EP is mired in poor profitability due to production declines at its E&P unit (a key to return to financial health), underperforming merchant businesses that it may not be able to exit for some time, and high interest expense that has exceeded reported operating income. Negative cash flows have moderated but potential for large deficits remain.”
To complete the plan will “depend on the positive alignment of numerous factors that may be outside EP’s control. It will take time to demonstrate its success in managing controllable factors, such as cost reduction, and improving profitability while continuing to reduce capital expenses.”
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