The energy and utilities sectors are among those where the pressure remains to effect “real” debt reduction in what likely will be a “quarter-in, quarter-out” battle, according to a new report by CreditSights analysts. The report found an 85% escalation in debt in the energy sector over the past four years — among the highest for the sectors — largely driven by the last few years of consolidation.

Debt of energy companies escalated soon after they benefited from high commodity prices and the natural gas supply bubble of 2000, which made the companies “eager to position themselves for an increasing share of the pie.” Leveraging then rose as companies began to use both debt and stock as currency for acquisitions. CreditSights found that the companies also used their healthy balance sheets as an easy access to more debt, and at the time, “high stock prices improved the economics of the transaction for acquiring companies.”

Although energy stocks “rose in tandem” with commodity prices in 2000, which caused the debt/capital ratio to fall, the companies then were pushed to higher debt levels from merger and acquisition activity. By 2001 and 2002, when the “increase in debt dominated and stock prices retreated, leverage ratios came under pressure,” although analysts found that the ratio was still only 3% higher than 1999 levels.

Now, however, with a struggling economy and stagnant stock prices, debt compared to earnings before interest and taxes (EBIT) “is elevated by industry standards” and many are working to return to the “2.5x-3x range over time” because most in the sector have fallen to “BBB” credit ratings.

In CreditSights’ analysis of the utility sector, companies were found to have “maintained their historical position as the most leveraged among the sectors, with debt/cap at over 60%.” However, a dispersion between utilities and other sectors has widened in recent years because of the continuing bad news that hit utilities and merchant traders.

“With the California power crisis and the collapse of Enron dominating headlines, we are a long way from 1999 to mid 2000 when utility stocks were considered a moderately safe haven for investors…” said analysts. “In fact, with the broader stock market starting to lose steam in late 2000, utilities and energy were the only two sectors where debt/cap fell on an annual basis that year. A year later, all bets were off after Enron defaulted in December 2001, and the sector experienced significant erosion in market cap in 2002.”

Debt increased between 2000 and 2001, “as companies were expanding generation facilities based on a rosy outlook for future earnings, and borrowing financed much of the asset growth.” CreditSights found that total debt for utilities increased 69% between 1999 and 2002, and “this does not include the numerous off balance sheet financing arrangements that were widely used at the time.”

CreditSights noted that “the spike in debt/EBIT to 7.0x from 4.8x is indicative of both of the pressure on operating margins across the sector and of the degree of restructuring that has taken place in the past 12-18 months.”

©Copyright 2003 Intelligence Press Inc. Allrights reserved. The preceding news report may not be republishedor redistributed, in whole or in part, in any form, without priorwritten consent of Intelligence Press, Inc.